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What the UK credit rating downgrade means for our money

Simon Ward
by Lovemoney Staff Simon Ward on 25 February 2013  |  Comments 10 comments

Credit rating agency Moody's has downgraded the UK's credit rating by a notch. But what impact could this have on our finances?

What the UK credit rating downgrade means for our money

The UK has had its credit rating downgraded by credit ratings agency Moody’s, but what does this mean and how will it affect our money?

What’s happened and why?

Moody’s has downgraded the UK's credit rating - essentially its ability to repay Government bonds or gilts (for more on these read Why gilts matter) - one notch from the much-prized AAA rating (the highest possible) to Aa1. It cited “continuing weakness in the UK's medium-term growth outlook”, the extension of the Government’s austerity programme beyond 2015, and the fact that the Government’s balance sheet may struggle to absorb a significant blow as the main reasons behind its decision.

However, many experts are calling this a psychological and political blow rather than one with longer-term financial consequences.

With the UK on so-called ‘negative watch’ for a while now, financial markets had priced in this move. So experts are not predicting a shock for the gilt market, for example.

Pound continues to fall

The slight exception to this is the currency markets. The pound has been steadily falling for a while now and this news sent it down again.

So far this year, sterling has lost nearly 7% against the dollar and 7.5% against the euro. Ed Bowsher looked at this volatility in more detail in his article Why the pound is falling and how it will affect you.

That’s bad news for us in terms of importing goods and services, for example food and oil (which will impact petrol prices). This in turn will push up inflation, still stubbornly above the Bank of England’s 2% target.

It will also impact British holidaymakers travelling abroad and expats who receive their income in sterling.

Of course, it's good news for exporters. But experts say the credit rating downgrade isn't going to be a major factor in the pound's longer-term future performance.

The Bank of England has indicated that it's happy to tolerate above-target inflation and a falling pound for now in return for growth in exports. Indeed, it seriously discussed injecting more money into the economy via its quantitative easing (QE) programme at its last Monetary Policy Committee meeting. If this happens, it will have a far bigger impact on inflation and the value of sterling.

Will the Government change course?

Another longer-term political impact could be on the Government’s future plans. Since coming to power, the Coalition has stuck doggedly to ‘Plan A’ – austerity measures designed to rebalance the nation’s books.

Chancellor George Osborne has repeatedly used the preservation of the AAA rating as justification for those measures. Whether this decision will force his hand remains to be seen, possibly as soon as next month's Budget.

What do you think of the downgrade? Will it force the Government to change course? Let us know your thoughts in the Comments box below.

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Comments (10)

  • Henry-GBG
    Love rating 57
    Henry-GBG said

    The loss of Britain’s triple-A credit rating is of course a result of the failure of government policies to pull the country out of the recession which began in 2008. From a longer-term perspective, however, the performance of the UK economy since the end of World War 2 can be characterised as a 15 year period of reconstruction followed by a continuous succession of crises, punctuated by three short credit-fuelled land price booms, each of which ended catastrophically, in 1974, 1992 and 2008. The same period also saw the de-industrialisation of the northern half of the country and the development of an intractable problem of regional economic imbalance.

    This miserable history suggests that there is something fundamentally wrong with the policies that have been followed according to the broad political consensus. Similar problems have to a greater or lesser extent affected countries as diverse as the US, Japan and Sweden.

    It would be wrong to regard the present economic difficulties as a “world problem”. They have largely passed-by countries such as Hong Kong, Taiwan and Singapore, which have been able to achieve consistent long-term economic development. It is not a coincidence that these administrations have operated with low taxes on individuals and companies, and instead, derive much of their revenues from the rent of land. In doing so, they have prevented a major cause of the persistence of the present and previous slumps in the UK – which is that land prices and rents are sticky-downwards. The forest of TO LET boards in Britain’s high streets and industrial estates tells us that rents are not falling to market-clearing levels, as free-market theory would lead us to expect.

    A major cause of the long-term problems with Britain's economy is the tax system, both negatively, in that it leads to a deadweight loss, variously estimated at between 12% and 30% of GDP (the lower end figure is bad enough), and positively, in that the absence of a direct tax on the annual rental value of land means that unproductive rent-seeking is better rewarded than genuine wealth creation. It gives chancellors no means of raising additional revenue to clear debts without damaging the economy still further.

    The tax system has distorted the whole economy. The need for reform is urgent, with a shift towards raising public revenue from a tax on the annual rental value of land...

    * has no deadweight cost;

    * cannot be avoided or evaded, as land cannot be hidden or removed to a tax haven,

    By putting a cost on holding land vacant, a land value tax promotes the efficient functioning of the land market, which essential to a healthy economy.

    MPs will have an opportunity to debate this on Friday 1 March. If they refuse to support the Bill, history will not forgive them.

    Report on 25 February 2013  |  Love thisLove  1 love
  • Yorkstyke
    Love rating 94
    Yorkstyke said

    Don’t be fooled by the siren calls of LVT.

    Given the chance, our corrupt politicians would simply introduce it alongside existing taxes, not in place of them as the above article suggests, thereby increasing your tax burden even further.

    Remember, governments don’t earn or make money, they simply raise money by taxing you and in the current economic climate they need every penny they can get their grubby little hands on.

    Beware!!

    Report on 25 February 2013  |  Love thisLove  0 loves
  • Henry-GBG
    Love rating 57
    Henry-GBG said

    @Yorkstyke

    Don't be fooled by the siren calls of no more tax at any cost. Or by scare stories about LVT. The government has a massive debt. All attempts to reduce spending significantly have failed. If Osborne could not do it, and his predecessors before 1997 could not do it, then it cannot be done. One reason why it cannot be done is because of the deadweight cost of all taxes raised by the current methods.

    LVT is the only tax with no deadweight cost. All others result in lost production because they are in effect acting as penalties on economic activity. Thus other taxes gives rise to the costs of mitigating the collateral damage they do. The introduction of LVT is a prerequisite for turning the tanker round.

    As for politicians with grubby fingers - the answer is to vote in better ones, is it not? But however good the politicians are, they cannot get the country's economy functioning with a tax system as dysfunctional as the one it has at the moment.

    Report on 25 February 2013  |  Love thisLove  0 loves
  • werwerwer
    Love rating 4
    werwerwer said

    Be warned! The loss of our "AAA" rating, though somewhat anticipated, signals a very serious problem for the UK that could/will affect every single one of us.

    It is a symptom of the fact that successive governments have put off dealing with their massive overspend that started decades ago. Putting it simply, the loss of "AAA" will cause the interest payments to go up on the money the Government owes and they are already in a situation whereby they can't afford to pay the interest.

    The Coalition is at least trying to do something about it (albeit as it has no choice), but possibly too little too late? Unfortunately, the general public will remember these bad times as caused by the Coalition when the reality is that the problem has brewed over decades and it "might" be the Coalition that sets us on the road to recovery.

    Don't get me wrong, I am not pro any party, but I have witnessed Labour spending relatively more and maybe taxing us less when in power (which the gullible public likes of course) leaving the debt to be paid in the future.

    Report on 26 February 2013  |  Love thisLove  2 loves
  • rbgos
    Love rating 86
    rbgos said

    The government is doing the right thing by addressing the debt problem that previous administrations (and I suspect previous Conservative governments have also been guilty of this, not just Labour) have continued to build up. If the loss of the AAA rating is a price to pay, so be it. We are not returning to growth because much of the developed world is in recession, and thanks to this government's actions we are riding the storm better than many other countries, despite starting off with a worse problem.

    Unfortunately, making the tough decisions hasn't been tough enough, and our debt is still growing. This is not an excuse for giving up and going back to the borrow-and-spend solution of the past, making the problem ever worse, as the opposition would seem to be advocating; we need to re-double our efforts and make the books balance.

    I would also advocate, as soon as we have achieved making income = expenditure, passing a law requiring all future governments to balance their books, so never again can a government borrow and spend their way to popularity, and leave the bills to be paid by the next generation. It should also ban all "off-the-books" ways of government borrowing, such as PFI.

    Report on 26 February 2013  |  Love thisLove  0 loves
  • CuNNaXXa
    Love rating 410
    CuNNaXXa said

    I think the problem with politicians is that they don't think ahead more than four years, which is the term they are guaranteed to get. We all know that general elections can see changes that wipe out the good or bad that predecessors had done.

    In fact, in the eighties, the monies made from selling the utilities and council housing wasn't spent on getting the deficit down, but on reducing taxation so that the current government would get yet another term in office.

    You have to question the motives of any government when they are purely self serving. Governments are supposed to support the society they represent, yet our ministers and Prime Minister seem more intent on retaining their time in office, and prioritise this above all others. Margaret Thatcher actually admitted that she sold off the council houses to create more home-owners, therefore creating more Conservative voters. If this isn't an excellent example of self serving, then I cannot think of any other example.

    So, given that our politicians always look towards the next General Election, and how to pay us to vote for them, are they actually right for the job? Should we not employ people on a longer term contract to work towards sorting out our financial mess, without the added burden of politics?

    We need a group who strive to do what is best for this country, and who aren't self serving, or constantly fighting each other, and spending precious cash doing so.

    Does our political system really work? Are the best people for the job being promoted to such, or are we still seeing people being cherry picked for positions based on who they know, and not what they know.

    Only when we can remove corruption from our current governing system can we start working towards a system that may actually work. The current system doesn't, and hasn't since the last World War.

    Report on 26 February 2013  |  Love thisLove  1 love
  • Yorkstyke
    Love rating 94
    Yorkstyke said

    @Henry-GBG

    I don’t have a problem with the theory of LVT, as I said above, my concern is that politicians will simply see it as an opportunity to tax us even more.

    And better politicians? There’s no such thing. Regardless of which party they belong to, they’re all in it for the same reason and that isn’t for the benefit of the electorate but for their own avaricious purposes.

    The whole political class is corrupt and will continue to be as long as the British public is dumbed down through poor education and the cult of celebrity. The Roman Empire was run on the principle of bread and circuses for the masses and Britain today looks very similar with it’s kebab / burger and celeb culture although part of that might be undone by the horsemeat scandal!

    Report on 26 February 2013  |  Love thisLove  1 love
  • rbgos
    Love rating 86
    rbgos said

    CuNNaXXa,

    Well, there is such a system of government as you propose - it's called Totalitarianism, of various flavours. Got somewhat out of control in Germany in the 30's and 40's, and ultimately led to economic and political collapse in the USSR and it's satellite states. China seems to be making a fairly decent shot of it, at last, although it's still burdened with widespread poverty and human rights abuse.

    Unfortunately, when someone is is given the reigns of power for long enough to be able to make a decent long-term plan ahead, they tend to abuse that power even worse than those who only get 4-5 years at a time.

    As Churchill said: "...democracy is the worst form of government except all those other forms that have been tried from time to time."

    At least, by adding a legal obligation to balance the budget, we might be able to limit one of the current major abuses of the system.

    Report on 26 February 2013  |  Love thisLove  0 loves
  • CuNNaXXa
    Love rating 410
    CuNNaXXa said

    @ rbgos...

    I read an interesting David Eddings novel whereby a small island was run as a democracy, electing those to run the island by public vote. One condition of the democratic system was that during their term in office, they had to hand over all their business dealings to an independent advocate who would look after their business interests for the duration.

    Depending on how well they ran the economy dictated how well their own business would weather their term, without them at the helm.

    One of the key problems with modern politics is that too many politicians see politics as a way of forwarding their own business career. If a politician was asked to hand over their business for the duration of their term in politics, how many would do so willingly. Probably none.

    Now some say that businessmen and woman make the ideal politician, because where they already run a business, they will know how to run a country. This is a fallacy. The businessman or woman is usually the investor, who pays employees to do research and development. The ability to make money does not automatically confer intelligence.

    When I see politicians, what I see are people who are versed in posture and gesture. They may be as thick as a plank, but if they can shout down their opposite number and gesture properly using arm movements, we will vote for them.

    We should be questioning the education of our MPs. Do they hold the requisite knowledge and background to do the jobs they are asked to do? Are they transparent enough for us to trust them.

    Some years back, under Leighbour, they commissioned a report to prove that Speeding Kills. The report, instead, proved that speeding wasn't a dominant factor in road deaths, and was subsequently buried by the Leighbour party, because it didn't state what they wanted it to state. How many times have researchers had to redo their research until it states what they WANT it to say?

    We live in a world where our leaders keep us in the dark, or feed us bullshit. The whole debacle over Saddam Hussein and his Weapons of Mass Destruction is one such point, even to the simple fact that a key witness committed suicide after his testimony was manipulated. An entire invasion, whether it was justified or not, was based on a lie.

    So, how can we judge a group who are so removed from the rest of us that they don't feel the pinch when we are in recession, who worry about which home they should use tonight, and are concerned whether they might have to switch Jags halfway through their journey.

    Oh, and before anyone says that they do this country a great service, no politician is in it for the country, they are in it for themselves, and what they can get out of it for themselves. After all, smoking kills, yet Mags became a consultant for a tobacco company, even though the NHS, backed by the government, were actively trying to get us to QUIT.

    Report on 27 February 2013  |  Love thisLove  0 loves
  • SiGl26
    Love rating 26
    SiGl26 said

    So, no comment yet that it was the same credit rating agencies that directly precipitated the banking crisis, by rating toxic debt liabilities as AAA assets? I'll make it then...

    I'd prefer any BBB gilts to a US bank's AAA sub-prime residential mortgage (over simplification I know, but the truth at its core)

    Report on 28 February 2013  |  Love thisLove  0 loves

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