• Charles Heighton

Why did Moody’s downgrade UK government debt and what does it mean?

By Charles Heighton – The London Financial Markets Editor and VP of Trading at King’s Global Markets

The rating agency Moody’s announced on the 16th of October that the UK government debt had been downgraded from Aa2 to Aa3. This puts UK debt on the line between high and upper medium grade debt. This may cause the price of UK gilts to fall when the market opens, although this may already have been factored into current prices. Recent history has shown that this may mean nothing for UK bond raisings. In theory, it should make raising debt more expensive, however in 2016 when the UK lost its AAA rating, gilt yields actually fell.

Even if this has no effect, the reasons given by Moody should be of interest. Three different but connected reasons were stated in the press release. The first is that the UK’s economic strength has diminished, in Moody’s opinion, since the last downgrade in late 2017. The reasons for this fall in economic strength are Brexit, the lack of a comparable EU-UK trade deal, and the knock-on effects of the coronavirus pandemic. While all of these headwinds are fairly obvious, the language suggests that the first two factors were enough for this downgrade. This may imply that a further downgrade is possible if the effects of coronavirus get even worse – although this is pure conjecture. They also believe that the UK economy will be the hardest hit G20 country, which is not a good sign.

The second stated issue is an erosion of fiscal strength. The pandemic has forced government debt to very high levels and it remains sticky, meaning that it has changed little, especially since the financial crisis. The wording seems to suggest that the UK's ability to carry debt, because the pound is a reserve currency, may be reaching saturation. This is concerning to Moody’s as they do not believe that any clear plan to reduce this debt burden has yet been formulated. In reality, Moody’s believes that an austerity program is needed but in the current political environment, this seems like an impossibility. The wording also once again suggests that the increased spending that started before the pandemic may also have led to this outcome. So the pandemic has certainly exacerbated the problem.

The final reason is the belief that the UK’s institutional policy effectiveness has declined. What this means is that UK political and governmental decisions have become less predictable. I imagine the ease at which the government suggested breaking international law is a good example of this. The release also has undercurrents of a lack of trust in the sitting government, which has already shown an ‘increasing willingness to move the goalposts’.

In reality, this may not affect existing debt or the UK government's ability to issue more gilts.

However, parts of the statement show an almost lack of trust or faith in the current government. The Labour Party has already seized on these elements as one would expect. Whether it is appropriate for a rating agency to rate a political party is a question for another time. What is clear is that this news is not good for a speedy economic recovery, nor is it positive for Boris Johnson's cabinet.




What do you think? Let us know in the comment section below!

Interested in writing for us? Click on the 'Write For Us' button at the top of the page!

Click here to visit WallStreetOasis.com


Recent Posts

See All