Moody's UK Downgrade
Global Economics Weekly Brief
Moody’s, the rating agency, downgraded the UK’s sovereign credit rating by one notch, from AAA to AA1. Despite the headlines, this shift is unlikely to have a material effect on the UK economy. It is more a symbolic and political loss. The markets had, in effect, downgraded the UK already. Sterling has been falling for several weeks, for the same reasons that prompted Moody’s to change the UK’s credit rating. * See Special Moody's UK Downgrade Report below...
The key concern is the UK’s medium term outlook. Moody’s now expects that sluggish growth “will extend into the second half of the decade”, making the government’s fiscal consolidation process harder. More pressure on the UK government to cut borrowing rapidly!
Bank of England divided. Three out of the nine members of the Monetary Policy Committee (MPC) voted for a £25bn increase in quantitative easing (QE) in February. David Miles was the only member arguing for more stimulus the month before. Most surprising was the shift in stance by Governor King, who recently played down the effectiveness of further QE. The MPC also discussed alternative stimulus measures, such as rate cuts or buying assets other than Government Bonds. Mark Carney doesn't take over until July, but the new Governor’s pro-active comments may already be having an impact. QE as been and still will be a waste of money and time - Look at history!
UK public finances disappoint. The sale of the 4G spectrum raised £2.3bn for the Treasury, below the anticipated £3.5bn and just 10% of the 3G sale in 2001. This represents another blow – albeit small – to the deficit reduction programme. A weak economy isn’t helping, with corporate tax receipts weaker than expected and welfare spending higher. It looks increasingly unlikely that the deficit will be lower this fiscal year than last. Despite these difficulties, Moody’s noted that the “UK’s creditworthiness remains extremely high” and the other two main rating agencies continue to rate the UK triple-A. UK public finances are still being wasted by civil servants, why?
Sterling continues to depreciate. The UK economy suffered a triple-whammy last week: disappointing public finance statistics; speculation over further monetary easing; with the Moody’s downgrade the final insult. It wasn’t therefore surprising to see sterling weaken further. The pound has fallen by 6% against both the dollar and euro so far in 2013. On the plus side, depreciation provides exporters with a competitiveness boost which should support trade. But a weaker currency is a double-edged sword. The drop in sterling makes imported goods more expensive, evidenced by a rise in oil prices to record high in sterling terms last week. This will not help the squeeze on real take-home pay!
UK unemployment rate down again. Unemployment fell to 7.8% in Q4, down from 7.9% in Q3 and 8.4% a year ago. The employment juggernaut rumbles on, with 154k people finding employment over the quarter. The number of economically inactive people has fallen to the lowest level since the crisis (in part due to changes in the female retirement age). The downside is that Britain's worst recovery in productivity in the post-war period intensified further over the course of 2012. The UK NEEDS FAR MORE EXPORTS!
Earnings growth remained subdued at the end of 2012. Once again, the 1.4%y/y growth in average earnings failed to keep pace with inflation. Over the course of 2012, it has been changes in income tax, increased pensions payouts and unemployment benefits that have helped real disposable income. Public sector average earnings grew faster than private sector earnings in Q4, repeating what happened in Q3. Average earnings growth in the retail, wholesale and hotel & restaurant sectors grew the fastest at 2.4%y/y, while earnings in the construction sector fell again, this time by -0.4%y/y.
Like the Bank of England, US Fed uncertain on what to do. The Federal Reserve left policy unchanged in January, but the minutes show this decision was far from straightforward. The Fed's current policy is to buy $40bn of mortgage-backed securities per month until the labour market improves substantially. Some on the committee wanted the pace of purchases to slow before the labour market had improved, whilst others cited the Great Depression as an example of what can happen when stimulus is removed too soon. In the end, no agreement meant no decision to change course.
Eurozone still in recession? The Eurozone Purchasing Managers’ Index (PMI), covering manufacturing and services, dropped to 47.3 in February from 48.6 in January. This points to another quarter of contraction for the monetary union. The index for manufacturing slipped to 47.8, with a deeper decline only averted due to strong export performance in Germany. The gauge for the service sector meanwhile dropped to 47.3 from 48.6 with domestic demand weak across all regions. A big worry is France. The second-largest member state has been performing like a peripheral economy, leaving Germany shouldering much of the burden in the battle against the Eurozone.
UK credit rating downgrade: not quite platinum, but still gold standard.
Moody's UK Downgrade
Moody’s, the rating agency, downgraded the United Kingdom’s sovereign credit rating from Aaa to Aa1 on 22 February 2013. It gave three reasons for its decision. Economic growth is likely to be slow for the next few years, making the government's fiscal consolidation process harder. Government debt is set to continue rising. High debt makes it harder for the government’s finances to withstand any shocks or surprises that come along. Despite the headlines, this shift is unlikely to have a material effect on the UK economy. It is more a symbolic and political loss. Aa1 is Moody’s second highest rating. It means that the UK has a very strong capacity to meet its financial commitments and is not in danger of defaulting. Moody’s says that the outlook for the UK’s rating is ‘stable’: they do not envisage another downgrade soon. The other two main rating agencies continue to rate the UK as triple-A. So, the UK may no longer be a platinum rated country, but it remains gold standard.
What is a sovereign credit rating and what is the difference between Aaa and Aa1? Like people and businesses, countries are rated on their creditworthiness. A rating provides guidance on a country’s ability to repay its loans and is one of a number of factors that determine the interest rate that a government will pay to borrow. The three main agencies that make credit ratings are Fitch, Moody’s and Standard and Poor’s. When they rate a country they examine issues such as its growth prospects, fiscal position and the effectiveness of government policy making. Countries with a higher credit rating find it easier to access credit and on better terms (e.g. lower interest rates). Triple-A is the highest credit rating. Aa1 is Moody’s second highest rating and represents a very strong capacity to meet financial commitments. Relative to countries with a lower sovereign credit rating, the UK continues to have high economic, financial and governmental strength, and hence its creditworthiness remains very high.
Why has the UK been downgraded? Moody’s gave three reasons for its judgement. It expects economic growth in the UK to remain weak into the second half of the decade. Weak growth has made the government's job of eliminating the deficit and reducing debt on the planned timescale much harder. As a result, deficit elimination and debt reduction will continue into the term of the next UK parliament, increasing the political risks of it being achieved. High and rising debt will make it harder for the government to weather any storms that come along.
What impact will this have on the UK economy? This downgrade does not mean that the UK has defaulted on its debts, nor does it imply that the UK is in danger of doing so in the future. A one notch downgrade could result in increased borrowing costs for the UK as a result of an apparent lower creditworthiness, but the extent of any increase in borrowing costs will depend on the market’s perception of the strength of the UK economy relative to other countries. If investors continue to view the UK as relatively strong and a safe place to invest, then the impact on borrowing costs is likely to be minimal. Both the US and France saw bond yields continue to fall after losing their triple-A rating from one of the main rating agencies. This was partly because investors perceived the US and France to be safe places to invest relative
to alternative investments. Moreover, the possibility of a downgrade is usually known well in advance. Moody’s put the UK on ‘negative watch’ in February 2012 and in November said they would review the UK’s rating in early 2013. Thus, the
likelihood of the downgrade has already been factored into markets. If borrowing costs rise, this would put added pressure on the government’s financial position, making it harder for it to reduce debt and stimulate growth.
How long does a downgrade last and will the UK be downgraded again? A downgrade is not time limited. A further downgrade would take place if there was a material deterioration in the public finances or a weakening in political commitment to reduce the debt. Can the UK be upgraded? Yes. As much as the UK can be downgraded, it can also be upgraded. The UK will be rated Aa1 until the economy grows sufficiently and the ratio of debt to GDP falls by enough to warrant a return to Aaa. Historically it has taken around 10 years for a country that has lost its triple-A rating to regain it.
Moody’s Rating Scale and long term rating examples
Sovereign ratings Corporate ratings
Aaa Canada, Germany, Netherlands Johnson & Johnson, Microsoft
Aa1 France, United Kingdom Canon, Royal Dutch Shell
Aa2 Kuwait, Qatar, UAE 3M, Wal-Mart
Aa3 China, Japan, Korea Coca Cola, General Electric, Toyota
A1 Czech Republic, Israel GlaxoSmithKline, Intel, Samsung
A2 Poland, Slovakia BP, BMW, McDonalds
A3 Malaysia, Malta Vodafone, WM Morrison
Baa1 Mexico, Russia, South Africa BSkyB, Dell, Tesco
Baa2 Brazil, Italy, Slovenia Carrefour, Time Warner, Toshiba
Investment grade (prime)
Croatia, Iceland, India, Spain GAP, Marks & Spencer, Sony, Starbucks
Ba1 Hungary, Ireland, Turkey General Motors, ITV, Virgin Media
Ba2 Armenia, Jordan Foot Locker
Ba3 Angola, Nigeria, Portugal Fiat, Nokia, Saks
B1 Fiji, Kenya, Sri Lanka British Airways, Avis
B2 Cambodia, Venezuela, Vietnam DFS Furniture, United Continental Airlines
B3 Argentina, Egypt, Ukraine Alcatel-Lucent, Sears, Tui Travel
Speculative grade (non-prime)
Cuba (Caa1), Pakistan (Caa1), Cyprus
(Caa3), Greece (C)
Source: Moody’s, Bloomberg
World Economic Outlook (WEO)
Coping with High Debt and Sluggish Growth - http://www.imf.org/external/pubs/ft/weo/2012/02/pdf/text.pdf
The World Economic Outlook (WEO) assesses the prospects for the global recovery in light of such risks as the ongoing euro area crisis and the "fiscal cliff" facing U.S. policymakers. Reducing the risks to the medium-term outlook implies reducing public debt in the major advanced economies, and Chapter 3 explores 100 years of history of dealing with public debt overhangs. In emerging market and developing economies, activity has been slowed by policy tightening in response to capacity constraints, weaker demand from advanced economies, and country-specific factors, but policy improvements have raised these economies' resilience to shocks, an issue explored in depth in Chapter 4.
Global economic outlook for 2013 revealed - United Nations ...
China Export Growth Collapses as World Recovery Slows - click on the connection below for comprehensive information.
10-Step Double-Dip Recession Survival Guide for Entrepreneurs - click on the connection below for comprehensive information.
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Note: About the Author Colin Thompson
Colin is a former successful Managing Director of Transactional/Print Manufacturing Plants, Print Management/Workflow Solutions companies and other organisations, former Group Chairman of the Academy for Chief Executives and Non-Executive Director, helping companies raise their `bottom-line` and `increase cash flow`. Plus, helping individuals to be successful in business and life in general. Author of several publications, research reports, guides, business and educational models on CD-ROM's/Software and over 400 articles published on business and educational subjects worldwide. International Speaker and Visiting University Professor.
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The Central Banker Problems!
Moody's UK Downgrade and the global implications.