Bloomberg News

Osborne Keeps Austerity as Investors Discount Downgrade

February 25, 2013

U.K. Chancellor of the Exchequer George Osborne

United Kingdom Chancellor of the Exchequer George Osborne leaves the Treasury building for the Houses of Parliament in London. Photographer: Chris Ratcliffe/Bloomberg

U.K. Chancellor of the Exchequer George Osborne won’t bow to opposition calls to change economic plans after the decision by Moody’s Investors Service to strip the U.K. of its Aaa status.

Osborne said in an article for the Sun newspaper yesterday that the government should “stick to its course” to reduce Britain’s debt. The opposition Labour Party called on him to switch his emphasis from deficit reduction to growth, following what it called Moody’s “humiliating” decision. Labour Treasury spokesman Ed Balls will question the chancellor on the downgrade in Parliament in London today.

The downgrade of the U.K. to Aa1 sparked a round of political sparring after Osborne repeatedly referred to retaining the top rating as a test for his economic policy. At the same time, investors and economists said rating cuts are a poor indicator of fiscal health. U.S. and French yields are lower than they were when rating companies downgraded the nations over the past two years.

“The rating change tells us only what we already knew,” said Rob Wood, an economist at Berenberg Bank in London. Still, “the change could put a little more pressure on sterling, a lot more pressure on Osborne, and may dent near-term growth a little.”

The pound today weakened against all but the yen among 16 major currencies tracked by Bloomberg. It fell 0.3 percent to $1.5115 as of 1:35 p.m. London time after earlier dropping to $1.5073, the weakest since July 2010. It declined 1.1 percent versus the euro.

The yield on the 10-year gilt rose 3 basis points to 2.14 percent. That compares with a record low of 1.407 percent on July 23 and an average of 3.945 percent in the past decade.

Osborne Testimony

Mark Allan, an economist at Axa Investment Managers in London, said the rating cut by Moody’s was “no surprise.”

Still, while the uncertainty over the timing of the downgrade “has been reduced by this decision, it is only the start of the political pressure,” he said.

Labour said it expects Balls to question Osborne on Moody’s in the House of Commons at about 3.30 p.m. The chancellor is then due to give evidence to U.K. lawmakers at the Parliamentary Commission on Banking Standards at about 4:30 p.m. in London.

Osborne said yesterday that the downgrade was a “stark reminder” of the “single most important truth about our economy; Britain has a debt problem, built up over many years, and we have got to deal with it.”

Weak Economy

Moody’s blamed the downgrade on the “continuing weakness” of the U.K. economic outlook and the challenge this poses to Osborne’s fiscal plans. While the U.K. retains “considerable structural economic strengths,” Moody’s also said its rising debt burden reduces its “shock-absorption capacity.”

The economic recovery is also troubling the Bank of England, where Governor Mervyn King and two other policy makers voted to increase stimulus this month. While they were defeated at the Feb. 6-7 meeting, officials discussed a range of measures to help the economy, including steps to boost credit.

The British Bankers Association said today that mortgage approvals fell to a four-month low of 32,288 in January from 33,440 in December. Approvals dropped 14 percent from a year earlier, partly due to cold weather.

“January’s severe weather impacted adversely on what was already a subdued picture,” said David Dooks, BBA director of statistics. “While general economic growth stalls, low consumer and business confidence generates a natural tendency to restrain borrowing appetite.”

Downside Risk

Britain’s economy shrank 0.3 percent in the fourth quarter. The Office for National Statistics will publish details on Wednesday, including data on consumer spending, government spending and exports.

“The risks to the growth outlook remain skewed to the downside,” Moody’s said. “Despite considerable structural economic strengths, the U.K.’s economic growth will remain sluggish over the next few years.”

Moody’s said part of the U.K.’s poor outlook is due to the “anticipated slow growth of the global economy.”

China’s manufacturing expanded at the slowest pace in four months in February, a survey today showed. A preliminary index fell to 50.4 from 52.3 in January, below the 52.2 median estimate of 11 analysts in a Bloomberg News. A number above 50 indicates expansion.

Market Impact

“We don’t expect much market impact from the downgrade -- it was widely expected,” said David Tinsley, an economist at BNP Paribas SA in London. “But this all comes at a time of poor news flow and highlights the U.K.’s vulnerabilities.”

Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook last year, according to data compiled by Bloomberg published in December. That’s worse than the longer-term average of 47 percent, based on more than 300 changes since 1974. Investors ignored 56 percent of Moody’s rating and outlook changes and 50 percent of those by S&P.

Britain’s debt as a percentage of gross domestic product will climb to 98 percent next year from 90 percent last year and 95.4 percent in 2013, the European Commission said in its winter forecast on Feb. 22. Tinsley said other ratings companies may also downgrade the U.K.

Osborne said in his autumn statement Dec. 5 that he’s no longer likely to meet his target to begin cutting the burden of government debt in 2015-16. Standard & Poor’s put the U.K.’s rating on a negative outlook a week later.

Fitch Ratings, which lowered its U.K. outlook in March 2012, said on Dec. 5 that missing the debt target weakens the U.K.’s credibility. It will review the rating in 2013 incorporating the budget, due March 20.

Fiscal Squeeze

“Far from weakening our resolve to deliver our economic recovery plan, this rating decision redoubles it,” Osborne wrote in the Sun article yesterday.

Ed Balls, Labour’s economy spokesman, said Osborne should scale back his fiscal squeeze and refocus on growth in his budget on March 20.

“In the budget, the government must urgently take action to kick-start our flat-lining economy and realize that we need growth to get the deficit down,” Balls said.

Shahid Ikram, head of sovereigns and chief investment officer for the U.K. at Aviva Investors, said asset purchases by the Bank of England, where Bank of Canada Governor Mark Carney will start work in July, will have a greater impact on gilts than the downgrade.

“If the central bank decides to stop buying, gilt yields will have to rise further,” Ikram said. “But again, there will be investors out there, such as sovereign wealth funds, who would bid for gilts when yields are higher.”

In terms of gilts, “the dominant factor remains the prospect for more QE, which we think is likely,” Michael Amey, portfolio manager at Pacific Investment Management Co., said in an e-mail.

To contact the reporters on this story: Thomas Penny in London at tpenny@bloomberg.net; Scott Hamilton in London at shamilton8@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net


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