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Just how safe is the UK’s AAA rating?

02 Dec 2011, by Guest in Economics

Just how safe is the UK’s AAA rating?

I ask because if I worked for a Ratings Agency I would currently be going through the OBR’s new forecasts and asking myself again and again, how long can I continue to give this country the top rating?

Consider the facts. The OBR has rather helpfully (in Box 4.4) provided some international comparisons of the UK’s debt and deficit position. As they note:

Relative to the main European countries, the UK deficit remains high in 2013. The UK’s Treaty debt levels are now close to the euro area average.

As can be seen our deficit compares unfavourably with France, Italy and Spain whilst our debt, although better than either Italy, is higher than Spain’s and very similar to France.

Our growth doesn’t compare too well either. The latest EC forecasts have the UK growing at 0.6% in 2012 and 1.5% in 2012 not very different from France at 0.6% and 1.4% (the OBR forecasts are higher).

Furthermore the fact that austerity is now due to stretch into another Parliament reintroduces what a ratings analyst what call ‘political risk’.

The straight forward thing is that whilst the markets and press and gripped with speculation about France losing its triple A the UK has a higher deficit, similar debt and similar growth.

What’s more I still think that the OBR’s growth forecasts  look to be on the high side, something which today’s Economist appears to agree with me on:

The economy will grow by just 0.7% next year, and by 2.1% the year after. Even these figures look too sanguine

Fitch has already fired a shot across the bows:

However, the deterioration in the economic and fiscal outlook implies that
net public sector debt will peak at 78% of GDP compared to the previous OBR
forecast of 70% in 2014-15. On a broader measure of government debt used by
Fitch in international comparisons, the UK government will become the most
indebted of any ‘AAA’-rated sovereign with the exception of the US
(‘AAA’/Negative Outlook). UK government debt is on this measure projected by
the OBR to peak at 94% of GDP and compares with Fitch projections for Germany
and France of 83% and 92% respectively.

As with some other major ‘AAA’-rated sovereigns, unless off-setting measures
were adopted, the capacity of UK public finances to absorb adverse economic and
financial shocks that would result in yet higher public debt while retaining
its ‘AAA’ status has largely been exhausted.

The problem isn’t that the government hasn’t been ruthless enough in cutting – it’s simply that the economy isn’t growing. And as the case of Italy demonstrates low growth can be as much of a problem as high deficits for bond investors.

Could it be the case that the great economic surprise of 2012 is the UK being placed back on negative outlook?

13 Responses to Just how safe is the UK’s AAA rating?

  1. elbapo
    Dec 2nd 2011, 12:51 pm

    Arent you ignoring some pretty vital differences in the UK context? firstly that we are not in the Euro, and so can devalue and control our own interest rates. More importanly, we are not in the Euro, and the bank of England is prepared to act as lender of last resort and can and is prepared to print money in the instance where uk bond investors ever may risk not getting their money back. That is the main structural problem with the Euro, it is not a crisis of liquidity or solvency (yet) but one of market confidence. Q: How confident is the market in the UK? A: lowest interest rates in history. Ratings agencies would be mad to downgrade us considering how risky the competition is.

  2. elbapo
    Dec 2nd 2011, 12:54 pm

    sorry insert *the lack of this*… is the main structural…(in reference to ECB not acting as LOLR)

  3. M I
    Dec 2nd 2011, 2:04 pm

    Good post on the debt levels!

    One question though – given the reputation of rating agencies after the crisis, and that they tend to be lagging indicators, why do we place so much emphasis on them?

  4. Splippy
    Dec 2nd 2011, 2:17 pm

    The duration profile of the UK debt is such that comparatively little is due for redemption in the short term. This is a big plus for the UK thanks to the DMO.

  5. Duncan Weldon

    Duncan Weldon
    Dec 2nd 2011, 2:32 pm

    M I,
    Personally I don’t think a downgrade to AA is a economic disaster but politically difficult for the govt.

  6. Duncan Weldon

    Duncan Weldon
    Dec 2nd 2011, 2:33 pm

    Splippy,
    Agree entirely – the long term nature of the debt means we are less exposed to a bond sell off. On the flipside we benifit less from record low yields.

  7. Duncan Weldon

    Duncan Weldon
    Dec 2nd 2011, 2:35 pm

    Elbapo,

    We do have an independent central bank – although so does the (downgraded by S&P) US.

    At the moment QE is a huge prop to gilts.

    I’m not even sure a downgrade would mean higher yields – it certainly hasn’t in the US and it didn’t in Japan.

  8. Matthew
    Dec 2nd 2011, 5:35 pm

    I don’t think the bond markets pay attention to the Ratings Agencies, if you look at the timing of interest spikes in PIGS’s government debt you’ll notice they tend to coincide more with downgrades of growth and downgrades of debt by some idiots in New York.

    And actually the low interest rates make complete sense if we go back basic wicksellian/Keynesian ideas about savings and bonds, the developed world’s private sector is deparately trying to save. Where else are they going to put their money (seriously this is such a forgotten basic point)? Use the bloody IS-LM framework!

    The only place the explanation fails is in the Eurozone where the hybrid stealth-currency/banking/balance-sheet crisis throws the rule book out the window.

    In the US, Japan and the UK we’re just in standard negative-feedback depressions where we sleep-walk to eventual Government debt crisis (presumably but Japan’s shows that can take decades) and the glut of private sector savings floods into Government securities, all the while suffering unemployment and low growth, and probably deflation.

  9. paul
    Dec 4th 2011, 11:29 pm

    duncan,

    have u considered the is/lm model and the effects of debts and interests levels in a liquidity trap that the world is in now
    i think we need to start there did u notice that even when the agency cut the us credit rating us interst rates did not go up!
    i thinl the is/lm model is quite useful thsses days

  10. Gareth
    Dec 6th 2011, 3:31 pm

    Nominal growth is what matters for debt/GDP, not real growth. If you say our growth prospects are “similar” to the Eurozone, you are looking at the wrong numbers.

    The IMF forecasts for nominal GDP growth in the UK were 4/5% as recently as September, as opposed to sub-3% for most of the Eurozone. That is a massive gulf.

    Italy might well get low real growth *as well as deflation* unless the ECB change course. Do you think the BOE will allow CPI inflation to fall below 2% in the UK in 2012?

    Monetary policy drives nominal GDP growth, not fiscal policy.

  11. OBR analysis suggests greater scope to stimulate the economy now | ToUChstone blog: A public policy blog from the TUC
    Dec 14th 2011, 11:50 am

    [...] Chancellor’s austerity plan. And at any rate poor UK growth is looking increasingly likely, as Duncan has set out, to unsettle the ratings agencies. But presume for a second that a significant government stimulus [...]

  12. The other Dave
    Jan 17th 2012, 10:48 am

    I’m no expert, but I had to check on Gareth’s comment on nominal GDP growth. On this measure, the UK economy has contracted some 3.6% since 2008, yet I saw no mention of a S&P downgrade in this time.

    Isn’t it more down to the power of the markets and their ability to dictate terms to nation states?

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