Debt downgrade isn't a disaster

by Ed Bowsher on 14 February 2012  |  3 comments
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Moody's has said that it may downgrade the UK Government's debt during the next 18 months. Is this bad news for the likes of you and me?

Moody’s, one of the main credit rating agencies, has warned it may downgrade the UK’s debt status from AAA to AA. To use the jargon, the UK is now on ‘negative outlook.’

AAA status is normally awarded to any borrower who is seen as 100% safe. In other words, you should be practically certain that the debt will be repaid. So it seems that Moody’s is now worried that the UK Government’s debt is no longer 100% secure.

The agency has two main concerns: the UK economy isn’t growing fast enough, and we’re also very vulnerable if the Eurozone crisis deteriorates further.

So does the announcement matter?

Well, in theory, it might push up borrowing costs for the Government.

If Moody’s announcement persuades enough gilt investors to sell, gilt yields will rise and the Government will have to pay more interest on its debts. That could potentially lead  to further spending cuts and/or tax rises. What’s more, if gilt yields do rise significantly, interest rates on fixed rate mortgages could go up too.

On the plus side, some savers might get more interest on their cash while annuity rates could rise as well.

Poor credibility

However, there are no guarantees that Moody’s announcement will push up gilt yields. In fact, I think it probably won’t.

Let’s not forget that all the credit rating agencies – including Moody’s – have a rotten track record. Back in the boom years, they were happy to give AAA status to mortgage-backed securities which have turned out to be very poor investments. That track record means that Moody’s credibility is low and probably won’t move markets.

Moody’s certainly didn’t make much impact in the US when it made a similar announcement last year. The agency put Uncle Sam on ‘negative outlook’ in November, yet the US government’s long-term borrowing costs are now roughly where they were before the announcement.

A mess

Don’t get me wrong. The UK is in a mess. The Government’s debt is far too high, the banks are weak, and a euro collapse would inflict a lot of damage on our economy.

But I’d be very, very surprised if the UK Government ever defaulted on its debts. There are two reasons for this:

1.     The majority of the UK Government’s debt is long-term, so the UK doesn’t have to repay onerous levels of debt in the next five years.

2.     The UK has its own currency. That means the Bank of England can always ‘print’ more money to pay off debts. Or it can encourage inflation which reduces the real value of our debt.

So yes, it’s a shame that Moody’s has put the UK on ‘negative outlook’, but I don’t think it changes much.

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