Tuesday, 20 March 2012

UK credit outlook

Last week Fitch announced that its review of the UK's sovereign credit rating had decided to keep it at AAA but revise the outlook to 'Negative', meaning that it's more likely than not that it will decide on an actual downgrade in the next two years.  In February Moody's had done much the same thing (it has slightly different criteria).  The agencies are concerned in particular about the possibility of further adverse affects on the UK from the Eurozone crisis.

This is rather embarrassing for George Osborne and the Conservative Party - the first of the eight "benchmarks" in its 2010 election manifesto was "We will safeguard Britain's credit rating...".  But Osborne, being a politician, said that it shows he's right "This is proof that, in the current global situation, Britain cannot waver from dealing with its debts".  I suppose that had there been no negative outlook that would have shown him to be right also.

Fitch and Moody's give considered analyses of why it's reasonable to be cautious about prospects for the UK economy, and they're right.  But what they don't do is say what that's got to do with the likelihood of a default, which is what credit ratings are supposed to be about.  Countries can default for one of two reasons: either they can't pay, which can happen only if they issue debt in a currency they don't own, or they won't pay because the rulers don't want to.  Thus Greece has defaulted because its government couldn't get hold of enough euros to pay its debts (you might think it could have taken more extreme measures: it could have tried selling a few Mediterranean islands if it could find sufficiently wealthy and thick-skinned buyers).  Whereas the US was rightly downgraded last year by S&P because its politicians showed that in some circumstances they might choose not to pay.

Neither of these possibilities applies to the UK: politicians of both parties have shown no interest whatever in  a voluntary default, and willingness to support the bond market by buying bonds with (electronically) printed money - they can create all the pounds they need.  It's possible that in dire economic circumstances the pound would be severely devalued in order to pay the debt, but that should be no business of the ratings agencies: bond investors can hedge with FX forwards if they wish.

I'm struggling to work out what sovereign credit ratings are supposed to be for.


  1. I expect you know this better than me, but I assume they are factoring not a default, but the possibility of printing so much money that the payback becomes worth less (rather than worthless, ha ha). If I was wondering about buying UK bonds I'd be interested in this second type of semi-default, rather than the (as you say) very unlikely actual default.

  2. Belette, what you say is rational, but I think it gives the agencies too much credit. If they are concerned about inflation risk, then all sterling corporate bonds should be downgraded at the same time as gilts are downgraded. Their value is reduced just as much as gilts by inflation. Second, there is an obvious inflation risk in a booming economy, but I am not aware that the agencies downgrade countries that have booming economies.

    A less charitable explanation is that they don't understand that countries are not like companies - see http://notthetreasuryview.blogspot.co.uk/2012/03/fitch-joins-moodys-in-shooting-itself.html, and http://notthetreasuryview.blogspot.co.uk/2012/02/moodys-downgrade-both-osborne-and-balls.html