Bloomberg News

Pound Weakens After Moody’s Says U.K. Aaa Credit Rating at Risk

June 08, 2011

June 8 (Bloomberg) -- The pound weakened against the dollar and the yen after Moody’s Investors Service said the U.K.’s Aaa credit rating may be at risk should the government miss its debt-reduction targets amid slowing growth.

Sterling fell to the weakest in more than three weeks versus the yen even as Moody’s said the nation’s sovereign ranking is “stable.” The European Commission said yesterday that the U.K. government faces a “challenge” to implement its planned budget-deficit reduction program and some of its growth forecasts are too optimistic. Data today showed U.K. shop-price inflation decelerated in May.

“The vast majority of market participants are not currently expecting the rating agencies to act,” said Stephen Gallo, head of market analysis at Schneider Foreign Exchange in London. “There should be a higher risk premium in sterling as a result of this. The rating agencies should certainly take a more decisive decision on the U.K.’s rating.”

The pound weakened 0.5 percent to $1.6365 as of 4:29 p.m. in London and fell 0.8 percent to 130.70 yen after reaching 130.49, the lowest since May 16. It appreciated 0.3 percent against the euro to 89.03 pence, snapping a six-day decline.

“Our central scenario is that the U.K. rating remains Aaa and the outlook is stable,” Francesco Meucci, a Moody’s spokesman, said in an interview from Paris. “However, slower growth combined with weaker-than-expected fiscal consolidation efforts could cause the U.K.’s debt metrics to deteriorate to a point where we would reconsider our stance.”

No ‘Plan B’

Sterling has weakened 3.8 percent against the euro this year amid signs that the government’s austerity drive is damping growth and will compel the Bank of England to keep interest rates on hold. Chancellor of the Exchequer George Osborne said two days ago he rejected calls for a “Plan B” to scale back his deficit-reduction plan. The International Monetary Fund said it endorsed the government’s strategy, while cautioning that the U.K. faces risks to growth and employment.

Standard & Poor’s affirmed the U.K.’s AAA ranking in October, having previously warned it may lower the nation’s grade, after Osborne presented his plans for spending cuts.

Today’s British Retail Consortium report showed prices charged by retailers rose 2.3 percent from a year ago, the weakest pace this year, after advancing 2.5 percent in April.

U.K. bonds rose, pushing two-year yields to the lowest this year, before central bank policy makers announce their latest interest-rate decision tomorrow. Ten-year yields were four basis points lower at 3.29 percent, while two-year yields dropped three basis points to 0.86 percent. All 55 economists surveyed by Bloomberg expect the Bank of England to keep the main rate unchanged at a record low of 0.5 percent.

Interest-Rate Futures

Short-sterling futures yields for June 2012 fell three basis points to 1.25 percent as investors curbed bets for higher borrowing costs. Traders are speculating that the Bank of England will raise interest rates by 25 basis points in April, forward contracts on the sterling overnight interbank average show, according to data from Tullett Prebon Plc. As recently as February, investors bet the rate would be lifted last month.

“Any rate rise would completely spoil the government’s chances of achieving its fiscal goals,” said John Hydeskov, chief analyst at Danske Bank A/S in London. Sterling may weaken to more than 90 pence per euro, he said.

The 10-year breakeven rate, a measure of inflation expectations, increased one basis point to 314 basis points after investors bid for 2.3 times the amount of index-linked gilts sold at an auction yesterday and Iberdrola SA’s Scottish Power unit said it will raise domestic gas and power prices from August. It earlier advanced to 317 basis points, the highest level since May 5.

“The auction came very strong and we’re getting some follow-through there,” said Giles Gale, an interest-rate strategist at Royal Bank of Scotland Group Plc in London. There was also stronger demand for inflation-linked bonds “on the back of gas and electricity price increases,” he said.

--With assistance from Garth Theunissen in London. Editors: Daniel Tilles, Matthew Brown

To contact the reporter on this story: Paul Dobson in London at pdobson2@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net


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