The market’s response to the UK downgrade has reignited the debate about the significance of credit ratings agencies while bringing criticism on UK chancellor George Osborne, who
made protecting the AAA status a priority.
The pound fell to a 16-month low against the euro and a two and a half year trough against the dollar after Moody’s cut the UK credit rating by a notch on Friday.
Some say traders were anticipating a downgrade and had already priced it in, while others claim the ratings agencies are not as credible as they were.
Analysts have generally not questioned the basis for Moody’s decision: continued weakness in the UK’s medium-term outlook, an expected rise in public debt owing to low growth, and a reduced ability to withstand future economic shocks.
Analysts observed that the United States and France still enjoy low borrowing costs despite losing their AAA status. The US was downgraded by Standard & Power’s in 2011 and France had its rating cut by Moody’s three months ago.
“Sometimes the ratings agencies are best ignored,” says Trevor Greetham, asset allocation director, Fidelity Worldwide Investment.
Greetham argues that Osborne’s attempts to please the ratings agencies by the “inflexible application” of austerity caused the low growth that has now led to the downgrade.
Some observers say the downgrade will be politically awkward for the UK chancellor more than it is economically significant. George Osborne placed an emphasis on preserving the AAA rating as a measure of economic competence.
Osborne is now under pressure to relax austerity measures, though he says the downgrade will not cause him to change course. Some nevertheless hope the downgrade will legitimise the use of fiscal stimulus.
A number of economists are predicting the downgrade will have a modest, negative effect on the UK economy.
“This could push some investors that are forced to hold AAA rated assets to sell out of gilts, however, in a world where the pool of AAA rated assets is shrinking, we do not expect to see much of an impact,” says Schroders European economist, Azad Zangana.
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