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Investment Houses Comment On Britain's Credit Rating Downgrade
Tom Burroughes
25 February 2013
Editor’s note: Late
last week, Moody’s, the rating agency, cut the UK’s rating for debt from Aaa to
Aa1, the first time in over three decades that the country hasn’t had a
top-level ranking for creditworthiness. The move, while not unexpected – as suggested
by the relatively muted market reaction so far – highlights how the UK
government has a battle to restore the country’s reputation for solvency. Eyes in the wealth
management industry will soon turn to the annual budget statement of the UK government,
slated for 20 March. There has still been talk of moves such as a new tax on
the wealthy, in the form of a so-called “mansion tax”. Whatever happens next
month, it is clear that tax policy is currently being crafted amid very
difficult circumstances. In the opinion of this writer, the only long-term
solution lies in supply-side measures to boost growth, such as freeing up
labour and other markets, and through a simpler and crucially, lower tax
burden. That debate, however, can wait for another day. Back to the Moody’s
downgrade - here are some comments from the financial industry on what has happened. Ian Kernohan, Royal London Asset Management The likely downgrade
of UK
sovereign debt has been discussed for months, so this was not a surprise and
gilt yields have barely moved this morning. The political fallout may be
greater, given that the timing of the downgrade comes just ahead of The budget,
however neither partner in the coalition has an interest in triggering an early
election, so it looks as if the current shape of the austerity plans will
remain largely unchanged. Toby Nangle, head of Multi-Asset,
Threadneedle Investments The United
Kingdom is a monetary sovereign, and its
government bond yields overwhelmingly reflect the expected path of future Bank
of England policy rates. Yields are low because the market believes that rates
will remain low, and because of the Bank of England’s policy of quantitative
easing. By contrast, eurozone sovereign borrowing costs depend on not only the
expected course of ECB policy rates, but also market perceptions of
creditworthiness, and so fiscally troubled sovereign yields are correspondingly
varied. The government’s frequent comparison between eurozone countries and the
UK
borrowing costs has served principally to explain to the public the benefits of
pursuing a policy of fiscal restraint. This is not to deny the large structural deficit that the UK has in
place, nor that the main aim of the Treasury should be to eradicate this
structural deficit. Economists and political parties of all colours agree on
this point. The spectre of a rating downgrade taking the UK on a path
towards a Greece-like ‘market hell’ is not relevant. If anything, the UK’s worst case scenario would be to suffer a
crisis more analogous to Iceland’s
– where ratings downgrades coincided with a precipitous collapse in the
currency, the financial system, and domestic and international confidence - but
we are a long way from such a scenario playing out. Azad Zangana,
European economist at Schroders The downgrade therefore comes as no surprise, with the
economy double-dipping in 2012, and is currently on the verge of a triple-dip
recession. Indeed, both gilts and sterling have been under pressure since the
end of 2012, as speculation of a downgrade had been building. Moody’s did however revise up its rating outlook back to
stable, indicating that the UK
would not be downgraded further. Overall, this downgrade had been on the cards
for some time, and the market reaction this morning suggests there are bigger
concerns out there for investors, such as the elections in Italy for example.
Both Standard and Poor’s and Fitch also have the UK’s outlook on negative watch, and
so we expect the others to follow suit. This could push some investors that are
forced to hold ‘AAA’ rated assets to sell out of gilts, however, in a world
where the pool of ‘AAA’ rated assets is shrinking, we do not expect to see much
of an impact. The fallout of the downgrade is more likely to be felt in Westminster rather than
the City, where Chancellor George Osborne has used the ‘AAA’ rating as a
benchmark for economic competence. With less than a month to go before the 2013
Budget, the ‘strategic leaks’ of policy measures have been strangely absent
from the news. Osborne’s own party are calling for deeper cuts in spending,
with the savings used to cut taxes, while the opposition are calling for more
public spending. The ideological debate on the size of government does not help
the present situation. The Chancellor should take advantage of near record low
borrowing costs to fund long-term infrastructure projects, but at the same
time, should focus on structural reforms to boost productivity, which has
plummeted in recent years." Trevor Greetham,
asset allocation director at Fidelity Worldwide Investments The Coalition set out trying to please the
ratings agencies but the inflexible application of front-loaded austerity is
partly to blame for the lack of growth that led Moody's to downgrade its UK
sovereign debt rating on Friday. Government, consumers and the banking system
cannot all attempt to deleverage against a weak global backdrop without
damaging the economy. This is a classic case of Keynes' 'Paradox of Thrift'. Ironically, it was a deferral of government spending
cuts that lost America its
AAA rating in August 2011 but the US strategy of putting off fiscal
tightening until the economy is stronger looks to be paying off. US interest
rates remain exceptionally low, economic activity is well above pre-crisis
levels and clear signs of revival in the housing market suggest the economy may
be escaping its debt trap. "There is a lesson here. Sometimes the ratings agencies
are best ignored. They played a pernicious role in the run-up to the financial
crisis, assigning AAA ratings to flawed debt instruments linked to overheated
housing markets. The damage to bank capital ratios when these investments
turned sour is what created the credit crunch. Now, with economies facing
sustained consumer deleveraging pressure as a result, the same ratings agencies
have advised governments to add to the pain by implementing aggressive
austerity plans when their economies need as much support as the markets will
let them give. Mark Littlewood, director
general at the Institute of Economic Affairs, a think tank The damaging impact of ballooning national debt, public
spending raging out of control and tax rises should not be underestimated. Taking
immediate action to tackle the deficit must now be the priority. George Osborne
should focus on making sufficient savings in public spending to implement a
substantial programme of tax reductions. With the size and scope of the state
in Britain
at current levels it is no wonder our economy is so fragile. The stranglehold
of regulation is hurting business prospects on almost every front. In the lead
up to the budget Osborne would be wise to respond by taking urgent action. Ian Winship, head of sterling bonds, BlackRock “The
timing of this decision is surprising for several reasons. In terms of
the economic story we would seem to be past the worst and believe it
very unlikely that a factor such as the
collapse in construction activity that weighed on GDP in 2012 will
reoccur. Risk sentiment is currently strong, risk-free rates remain
low, bank funding costs have fallen... As a
result, credit availability is improving and the
price of that credit (mortgage rates) is falling. The
referenced medium-term growth outlook, which was downgraded by the
market last year and by the Office of Budget Responsibility in December’s
Autumn Statement, has if anything improved since then. In fact, the
current set of financial conditions in the UK – yields below 50 basis points out
to mid 2016, bank funding costs sharply down, currency weakening – put
the economy in the best situation for a recovery
that we have seen since the crisis. The
deficit has also benefitted from several one-off factors over the last
12 months (Royal Mail pension assets,
Bank of England QE coupons and profits from its SLS scheme, the 4G
spectrum auction) which have significantly reduced the near-term need to
raise money in the gilt market.