Sterling Moves Lower after UK Loses AAA Rating from Moody’s

The pound has touched a two-year low against the US dollar after credit ratings agency (CRA) Moody’s downgraded the UK’s AAA credit rating by one notch to Aa1 late on 22 February, the country’s first downgrade since 1978. 

The move leaves only nine countries in the world with AAA ratings from Moody’s and its peers Fitch Ratings and Standard & Poor’s (S&P). They include Australia, Canada, Denmark, the Netherlands, Norway, Singapore, Sweden and Switzerland. Ireland lost its AAA rating in 2009 and was followed by Spain in 2010, the US in 2011 and France and Austria last year.

The UK’s downgrade by Moody’s follow increased concerns that the Bank of England (BoE) could step up its monetary easing programme in an attempt to boost the UK’s sluggish economic growth, which has triggered selling of the pound in recent days.  The BoE’s incoming governor, Mark Carney, who takes up the post on 1 July, has also indicated that the BoE’s 2% inflation target will be ditched in an attempt to boost growth.

Moody’s itself cited the UK’s subdued economic growth prospects and a “high and rising debt burden” as among its reasons for the downgrade, adding that it now expects the period of sluggish growth that has afflicted the UK for much of the period since the 2008 global financial crisis to “extend into the second half of the decade”.

Damage limitation

However currency analysts said that much of the effect of the downgrade was already priced into sterling, as the three main CRAs put the UK on negative watch last year. “The downgrade was expected and priced into credit markets. Hence, we expect only a limited currency response in the short term,” said analysts at Morgan Stanley.

UK business secretary Vince Cable also attempted to dismiss the downgrade as “largely symbolic” adding that in terms of the real economy there was no reason that it should have any impact.

“If you remember last year the US was downgraded, the economy grew strongly relative to Europe and France had a downgrade last year, its interest rates that it borrows long term in the markets are only a little above ours,” he commented in a TV interview

“The rating agencies have a pretty bad record. They are a bit like tipsters. They get some things right and a lot of things not right.”

Kenneth Clarke, currently minister without portfolio within the Cabinet, who served as chancellor for four years from May 1993 to May 1997, said that the UK should follow a similar strategy to the US. “The Americans, like us, are going to persist with sensible policies combining getting rid of the debt and deficit at the same time as stimulating growth and having an industrial strategy,” he commented.

“It is going to take several more years of this to get back not just our credit rating but to sensible growth.”

However, eonomists expressed concerns that in the meantime the downgrade would aggravate the pound’s recent renewed weakness and undermine efforts to bring down inflation. “The danger is that the pound falls too far and becomes a serious inflation concern,” said Howard Archer, chief UK economist at IHS Global Insight. “Also, a sharp fall in the pound would not be good for confidence.”

Investor response

Robert Farago, head of asset allocation at Schroders Private Banking, said that investors in the UK “shouldn’t be unduly dismayed” by the Moody’s downgrade.

“There is very little to disagree with in Moody’s economic analysis of the economic outlook for the UK, but also no reason why a change in credit rating should have a sustained impact on UK equities or bonds,” he added.

“Outside the confines of the euro, there is no sign that markets are demanding a higher yield from countries with higher levels of debt – although there is no guarantee that this will remain the case, since the path to sustainable government finances remains a treacherous one.”

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