One of the largest credit rating agencies, Moody’s, has announced that they are considering downgrading the UK’s credit rating yet again. This comes as Brexit negotiations are looking increasingly uncertain and giving way to more political and financial risks.
Moody’s has announced that they believe the UK’s AA1-negative rating to be at risk, especially if the current UK government are unable to “preserve core elements of the UK’s current access to the EU single market”.
In their report, Moody’s said that they believed the UK government’s desire for a hard Brexit has increased the chances of an
“abrupt and damaging exit with no agreement and reversion to World Trade Organisation (WTO) trading rules”
The author of the report, Kathrin Muehlbronner, a Moody’s senior vice president, said that Theresa May’s appalling performance in the general election had caused increased risks. She did, however, caveat this by saying that the “base case scenario” for Brexit was that the UK and the EU manage to agree on a free trade arrangement because this “remains in the interests of both sides”.
Moody’s also announced that they expect the UK economy to worsen over the rest of the year. They predicted growth to decline to 1.5 percent this year, and just one percent in 2018, compared to 1.8 percent in 2016.
“Over the medium term, growth prospects would likely be materially weaker if the UK were to fail to reach a new trade arrangement with the EU that allows it good access to the single market,” the report said.
What does the current credit rating look like for the UK?
The current UK credit rating is not great. Prior to 2013, the British finance had an AAA credit rating – the highest possible – from all the credit rating agencies.
However, in 2013, Moody’s – one of the largest credit rating agencies – announced that they would be downgrading the UK from an AAA rating to an AA1 rating. This was the first time the UK had lost the highest level of credit rating since 1978.
At the time, Moody’s said “The main driver underpinning Moody’s decision to downgrade the UK’s government bond rating to AA1 is the increasing clarity that, despite considerable structural economic strengths, the UK’s economic growth will remain sluggish over the next few years due to the anticipated slow growth of the global economy and the drag on the UK economy,”
Other credit rating agencies did not immediately follow suit on downgrading the UK’s credit rating. Of the three big credit agencies, the next to downgrade the UK rating was Fitch. Later in 2013, Fitch also announced that they would be downgrading the UK to an AA+ rating, citing the country’s “deteriorating economic climate”.
It wasn’t until 2015 that S&P, the last of the big three, finally downgraded the UK’s credit rating following the referendum. After announcing that they would downgrade the UK’s credit rating by two notches, down to an AA rating, S&P also said that the referendum result could lead to “a deterioration of the UK’s economic performance, including its large financial services sector”.
The Brexit vote also caused Fitch to lower its rating from AA+ to AA, predicting an “abrupt slowdown” in growth in the short-term.
How are other major economies faring?
Not many countries still maintain an AAA rating from all three big CRAs. Currently, the only countries with AAA ratings from all three CRAs are; Australia, Canada, Denmark, Germany, Luxembourg, the Netherlands, Norway, Singapore, Sweden and Switzerland.
In terms of budget deficits, the UK government has one of the largest of any advanced economy. Public sector debt in the UK – excluding banks – has reached £1,606.9bn, according to the Office for National Statistics (ONS). That amount of debt is the equivalent of 83.7 percent of the UK’s economic output.
These big deficits across different sectors – trade, investment and public finances – mean that the UK has the worst external liquidity metric of any of the 129 countries that the major CRAs rate. Unfortunately, this, therefore, means that how much of the risk to the UK’s ability to finance itself is out of the country’s control.
Standard and Poor have calculated that using “gross external financing needs as a share of the sum of current account receipts and usable foreign exchange reserves”. This means that for the UK, we need external financing that is worth 810% of the current receipts we have from costs like exports, as well as currency reserves.
This isn’t good news. If you compare this with the USA, their figure is only 336%. The average figure for an AAA rated country is 192%. The better the economy, the lower the number.
The ONS said the Chancellor borrowed £74.9 billion for the financial year ending in March, overshooting the annual target by £2.7 billion. It was a setback for George Osborne in his efforts to shore up the nation’s finances after he pledged to return the UK to a surplus by 2020.
What does the credit rating mean for you?
These credit ratings apply to debts that the UK government sell at gilt markets. Government-guaranteed debt is sold to investors, who are looking for a return on their money.
If the UK has a lower credit rating, these debts can be seen as a riskier investment by investors. Therefore, they usually want a higher rate of return for their cash, which could artificially inflate UK interest rates up.
As well as the cost of raising debt, it may also be more difficult to sell it. Some major international buyers of debt are only allowed to hold AAA-rated bonds, meaning they would not be able to buy Government debt if it was downgraded to the next level down, AA+.
Another side effect of a decrease in credit rating is that it is usually accompanied by a decrease in the value of the pound. The pound did drop this morning after Moody’s report came out.
If the pound becomes weaker, this does help exporters but also makes imports more expensive. We can see this clearly with petrol, which has increased in price over the past month. More drops in the value of the pound could also put more pressure on household incomes, as well as company profits, and therefore on the economy as a whole.