In simpler times, both events taking place at the same time would have been unthinkable. But we have been through the looking glass for quite a while. The questions now are: what does this mean for fiscal and monetary policy? And what impact will this have on investors?
That Moody’s decided to downgrade the UK should have come as no surprise. The ratings agency has had the UK on negative watch for 11 months, and in the interim the economic and fiscal picture has deteriorated. The ability of the public finances to absorb shocks has also waned. The latest manufacturing data contracted in February for the first time in a year. With the sector accounting for 10 per cent of GDP, the dreaded triple-dip recession is now a real possibility.
Moody’s, however, is not alone. Standard & Poor’s (S&P) and Fitch still rate the UK at AAA, but both have it on negative outlook. Fitch said it would review the rating after the Budget on March 20. Alas, George Osborne’s prognosis was grim; a downgrade now looks all but certain.
But perhaps we are placing too much emphasis on the influence of ratings agencies. They are merely acting on information that is already available to the wider market. Aside from making for shock headlines, then, a downgrade is merely a confirmation of existing facts on the ground.
Secondly, since the collapse of Lehman Brothers five years ago, some of the lustre has come off the agencies. It was they who granted AAA rankings to subprime mortgages and collaterised-debt obligations, the instruments at the root of the crisis.
There is also the rating itself. Only two of the G7 nations – Canada and Germany – are currently rated AAA. The US was stripped of its top rating by S&P in 2011 after the political brinkmanship over raising the debt ceiling raised the prospect of default. True, Moody’s and Fitch still have the US on AAA, but have the country on “negative” watch.
France followed shortly afterwards on stubbornly sluggish growth and fears of eurozone contagion. The rest of the eurozone is worse, with Italy, Spain and Portugal hovering above junk status. In such a climate, then, what is the difference between AAA and AA1? When the US boasts the latter, the conclusion is – very little.
And, while a country’s rating is, in part, a reflection of the economic and political climate, what it actually signifies is the likelihood of default.
The UK and US have their own central banks, institutions that are able and, as we have seen with quantitative easing, willing to print their own money. Further, the UK was only downgraded one notch and the outlook remains “stable”. This, according to Moody’s, is likely to remain the case for the next 12-18 months. By contrast, France (Moody’s Aa1) and the US (AA+) remain on negative outlook. As one commentator said, in such a climate “stable is good.”
Graeme Caughey is global head of rates – fixed income at Scottish Widows Investment Partnership (Swip)
