On Friday 22nd February Moody’s downgraded the UK economy from AAA to AA1. The reasons Moody’s gave for the downgrade were that they consider the UK to have a weak economy and is suffering from sluggish growth.
The likely effects of the downgrade are:
- The pound will drop, which means our imports will cost more. This will lead to higher inflation which will result in more stress on the already beleaguered consumer.
- On the other hand, our products will be cheaper overseas, and that would be good for exporters.
Debt burden
The downgrade is a stark reminder of the massive debt burden we are carrying forward, and has effectively given the government no room to move with fiscal policy. It is my assertion that any tax decreases planned for the upcoming budget will not now happen!
Room for manoeuvre
The only potential room for manoeuvre is in monetary policy. It could be argued that with interest rates at 0.5% and Quantitative Easing at £375bn, much has already been done. The Funding for Lending scheme is having some positive effect on mortgage pricing and availability, but unfortunately not on lending to SME’s.
Should we borrow more?
With regard to the suggestion from many quarters that we should borrow more to stimulate growth creation (Ed Balls is advocating about £200bn more), it is worth making the point that this is already being done. George Osborne is already spending £92 billion more than he collects in tax over 2012/13 on this basis, but unfortunately this stimulus, which amounts to a mammoth 6pc of GDP, is not producing the hoped-for results. That is why we have been downgraded.
The recovery of the UK economy is an incredibly difficult turnaround strategy, with business finance at the very heart of it. Here are 15 need to know points about the rating agencies, the downgrade and the impact we can expect on the UK economy:
- The credit rating agencies have been around for more than a century, dominated by the big three of Moody’s (which downgraded Britain on Friday), Standard & Poor’s and Fitch. They came into existence to provide independent assessments of American railroads and other investment propositions for investors. But their prominence has grown in recent years, particularly because of their award of maximum Triple-A ratings for Lehman Brothers and the “sub-prime” securities that dragged the world into the financial crisis.
- The credibility of these agencies is under the microscope. S&P is being sued by the US government over ratings it gave to some mortgage-backed assets in the run-up to the global financial crisis in 2007, which subsequently fell dramatically in value.
- The last time the UK lost its AAA rating was 1978.
- Moody’s, Standard & Poor’s and Fitch all put the UK on “negative outlook” last year, meaning they could downgrade its rating if performance deteriorated.
- In his Autumn Statement in December, Chancellor George Osborne acknowledged public finances were taking longer to rectify than planned, and admitted he would be forced to extend austerity measures by at least another year.
- Moody’s downgrade sent the pound falling further in value; so far this year, sterling has lost nearly 7 per cent against the dollar while the euro has gained 7.5 per cent against the pound.
- The UK’s net sovereign debt was the equivalent of 68% of the country’s annual economic output, or GDP, at the end of last year.
- Germany and Canada are the only major economies (G7) to currently have a top AAA rating.
- A downgrade of a credit rating does not necessarily substantially damage the ability to borrow but is likely to increase the rate charged.
- UK 10 year bonds, seen as a proxy for the rate at which the Government can borrow, are at historically low levels, albeit they had risen from 1.7% to a high of 2.1% over the past few months. Since the downgrade, yields have dropped back below 2.00%!
- The US – the world’s biggest economy – was downgraded from its AAA rating last year, a move that has not materially changed its borrowing costs and has seen significant rises in the values of equities.
- Moody’s removed France’s AAA rating in November.
- The UK has experienced a double-dip recession since 2008. It grew in the third quarter of last year – boosted by the impact of the Olympics – but shrunk again by 0.3% in the last three months of 2012.
- Earlier this month, the Organisation for Economic Co-operation and Development said the Bank of England should be ready to inject more money into the economy to boost growth.
- The Bank of England has so far pumped £375bn into the financial system, creating money to buy back government bonds. The Bank of England currently accounts for approximately 40% of the Gilt markets.
Summary
In the complex picture that is the UK and Global economy’s, this downgrade has served as a warning to all policy makers that there is no easy option to get us back on track.
As in any company turnaround, there is a need for both cost reduction (austerity) and turnaround finance (Funding for lending)! The problem is that we became so addicted to easily available business finance in the good times, that it comes very hard when the finance is a little harder to find.
The SME, the lifeblood of all economies, is not benefitting from the additional finance that should be available from the Funding for Lending scheme, which would allow them to grow.
The previous behaviours of the drivers of the booming UK and Global economies pre-2008, have left us all with an incredibly difficult challenge in just restoring the UK to a period of stability, let alone average growth of 2 or 3% per annum.
As always if you have any comments about this or any of our other blogs, please contact me at john.thompson@transcapital.co.uk or on 0845 689 8750.
Image by: fatboyke (Luc)