First things first, this is definitely more of a political than an economic blow for the Chancellor. For better or for worse, he tied his reputation to the performance of Britain’s credit rating back in the run-up to the 2010 election. He inserted an explicit pledge that he would safeguard Britain’s credit rating in the manifesto that year.
Not to mention the simple fact that this is the first time since these ratings were first given to the UK in 1978 that Britain has lost its top-tier status. The Winter of Discontent, the miners’ strikes, Black Wednesday, a number of housing slumps: none of these merited Britain losing its AAA status. The fact that this current crisis is deemed more damaging is a major reputational blow – even allowing for the fact that in many senses Britain’s problems started under the Labour Government.
These days a rating downgrade is no longer the instant financial blow it once was. Whereas previously credit ratings tended to be hardwired into the system (for instance, certain central banks used to accept or refuse collateral based solely on its credit rating), that’s no longer the case. Moreover, this downgrade is about the least unexpected decision in recent economic history. Britain had been on negative outlook with Moody’s for a year (along with the other two major ratings agencies), and rumours had been floating around for weeks that a downgrade was imminent.
Plus, as you can see from the graph above, which traces Britain’s borrowing costs all the way back to 1703 (yes, really), it’s not as if the interest rates the Government is paying are high: they are in fact near historical lows (partly a consequence of quantitative easing, partly of low growth prospects).
However, even if a downgrade no longer triggers automatic financial oblivion, it nonetheless serves as a reminder of this country’s dismal economic prospects. The Moody’s statement was quite specific on this: the primary reason for the downgrade is that the economy simply isn’t growing (and shows little sign of growing) at the rate one would have hoped for. As a result, the amount of income generated by British companies and individuals (and hence tax collected for the Treasury) is disappointing.
That, in the end, is why the deficit is likely to be higher this year than last. And this is one problem no-one in authority – whether that’s the Chancellor, his opposite number, the Bank of England or others – seems to have a decent answer for. Every single Budget since Alistair Darling has been concerned with one simple question: where’s the growth coming from?
The most disturbing element of the Moody’s downgrade is what it says about this quandary. That doesn’t imply a sudden lurch in Britain’s creditworthiness. In fact, Moody’s have, importantly, changed the outlook on Britain’s rating back from “negative” to “stable”. S&P didn’t do this with the US when it downgraded it.
But it does reinforce the big fear – that Britain could be facing a long period of Japan-style stagnation, as it tries to work off its enormous debt load. Which means a lower pound, and which means suspicions of more quantitative easing from the Bank of England, as it tries to find the magic solution to revive this stuttering economy.