Apocalypse No: markets "react" to rating downgrade

Let’s get this straight: on Friday night Moody’s downgraded Britain’s credit rating for the first time since it started giving official ratings to the UK back in 1978. This means as far as it is concerned Britain is statistically more likely to default in the coming years.

Today the capital markets where the Government turns to borrow, where it is constantly judged by the people who in this case really matter (investors), gave their reaction, and it can be summed up in two words: “so what?”

As of about 10am, the rate investors charge the Government to borrow was actually lower than just before the downgrade (having ticked up a touch in early trading). The pound actually strengthened in comparison with where it was immediately after the downgrade. It’s still close to a three-year low against the dollar, but it’s been heading south for weeks. The FTSE 100 index of leading UK shares was up by 0.5%, and even banking shares, which plunged after Moody’s first warned of a potential downgrade this time last year, were stable.

The Government's cost of borrowing (the 10-year gilt yield) over the past three days. the downgrade happened after markets closed on Fri 22 Feb. Chart: Bloomberg
The Government’s cost of borrowing (the 10-year gilt yield) over the past three days. the downgrade happened after markets closed on Fri 22 Feb. Chart: Bloomberg

In other words, if you were looking for any palpable reaction to the downgrade, you would be hard-pressed to find it. This shouldn’t be particularly surprising: the notion that a downgrade would provoke economic and financial oblivion evaporated in 2011 when markets entirely ignored the US credit rating downgrade.

All of which brings us back to George Osborne. You might be tempted to portray today’s markets damp squib as good news for the Chancellor. Losing your AAA crown is not, it turns out, the end of the world. However, it’s also a reminder of one of the biggest mistakes of his political career.

There was no need for Mr Osborne to tie his economic record so explicitly with the country’s credit rating (particularly given the credibility of the agencies themselves). Had he promised instead to keep the government’s cost of borrowing low, he would have been able to boast that the interest rate has almost halved since he took office. Whether this political miscalculation deals him a lasting blow remains to be seen, but it’s clear that the downgrade is no financial disaster for Britain.

However, that shouldn’t distract us from what does matter: the underlying reasons for the downgrade. It is striking that the major explanation the ratings agency gave came down to Britain’s growth prospects. It said, quite simply, that this recession has been unlike any other of recent memory. The enormous amount of debt still hanging over households and businesses (let alone the Government) has meant that the UK economy is still, even five years on, smaller than it was before the crisis.

To put that another way, this country and its citizens are generating less wealth, taking home less income and spending less than in 2008. That’s why the deficit is still climbing and why the squeeze on household incomes is returning. In spite of all the money the Bank of England has thrown at the problem, and a massive of extra borrowing from the Treasury, Britain is in a serious economic pickle.

You don’t need a credit ratings agency to tell you that. And it turns out the markets didn’t either.