Moody’s has put Britain’s coveted AAA rating on negative outlook, making a downgrade more likely. What effect would this have on the country?
Credit ratings are significant because they reflect the state of a country’s economy and can affect borrowing costs. But one institutional investor told Channel 4 News that he would advise against selling British government bonds (gilts), even if the country was downgraded, because “you would be hard-pressed to find a relatively safer place”.
Moody’s said it had decided to place Britain on negative outlook for two reasons: the uncertainty over the government’s austerity programme in the light of poor growth, and the continuing turmoil in the eurozone, the UK’s most important trading partner.
The fear is that weak growth is hampering the government’s ability to reduce its debts because of falling tax receipts and higher unemployment.
The implication of the Moody’s decision is that there is now a 30 per cent chance that Britain will be downgraded in the next 18 months.
On 13 January, France’s rating was lowered from AAA to AA+ by Standard & Poor’s.
This caused embarrassment to the French government, just as Moody’s warning has given a mighty jolt to George Osborne, who would not like to go down in history as the chancellor who presided over the loss of his country’s AAA status for the first time.
He has made much of the fact that when he arrived at the Treasury, Britain had been put on negative outlook by Standard & Poor’s, but was taken off it when he demonstrated that he had a credible plan to balance the books.
Britain is heavily indebted. Its total debt adds up to more than £1tr, and it is borrowing billions every month to pay for public services.
France is also borrowing huge amounts of money. But since it lost its AAA status, its borrowing costs have not risen. In fact, they have fallen slightly from just over 3 to 2.9 per cent.
The US was stripped of its AAA status for the first time in August 2011. Its borrowing costs have also fallen from 2.5 to just below 2 per cent. Japan has been downgraded on several occasions, but it is not being penalised when it borrows money.
If investment decisions are made on the basis of which countries are comparatively safe, why would Britain be any different if its lost its AAA halo?
Big investment firms have agreements with some clients that a proportion of their holdings will be kept in AAA funds, including government debt, because they are judged to be safe. What would they do if Britain was downgraded?
Georg Grodzki, Legal &General's head of credit research, told Channel 4 News: "I would not advise in favour of selling gilts (British government bonds) for reasons of sovereign credit concerns. The question is what would you buy instead? With sovereign ratings coming down across the board, you would be hard-pressed to find a relatively safer place. It's difficult to replace gilts with anything less risky or anything giving higher yields."
Mr Grodzki said this advice was based "on the assumption that the government does not waver in its plans".
Frances Hudson, global strategist at Standard Life Investments, said her company used a weighted average from all three ratings agencies (Moody's, Standard and Poor's and Fitch), and if Britain lost its AAA rating, clients would have to be contacted. "If that is what the mandate says, then you abide by it," she said. "We would discuss whether to change the benchmark rather than strictly adhere to it."
Investors appear to be less perturbed by the views of a credit ratings agency than some politicians, for whom AAA status is a badge of honour.
The Treasury should stop obsessing about how they will react. Jonathan Portes, NIESR
Paul Dales, a senior economist at Capital Economics, told Channel 4 News: “Countries’ borrowing costs are determined by a number of factors and the whims of a ratings agency are one of the least important.”
Economic fundamentals were more significant, said Mr Dales, along with how safe a country was judged to be in comparison with others. “Much more important is the strength of the economy, the outcome for inflation and any safe haven flows.”
Jonathan Portes, director of the National Institute of Economic and Social Research, is a former senior economist at the Cabinet Office. He used to advise No 10 on economic and financial issues and, judging by his blog on Tuesday, has little time for the ratings agencies.
He says in his blog that Mr Osborne and Shadow Chancellor Ed Balls are wrong to try to extract political capital from Moody’s announcement, adding: “So how should the government, and the markets, respond to the rating agencies? The former should, and the latter in my view will, simply ignore them.
“The Treasury should stop obsessing about how they will react, stop inviting them in for presentations and discussions about the economic and fiscal outlook, and simply say, ‘We couldn’t care less what the ratings agencies say. The UK will pay its debts. We have a credible and sustainable fiscal policy and we will continue to do so’.”