The Coalition government began its term of office with a clear policy focus, clearly defined aims and clearly defined methods.Â George Osborne will be judged as a success or as a failure by the UKâ€™s ability to improve economic performance by reducing sovereign debt.Â To this end, cuts to welfare, to pensions and to benefits have been made, over objections from MPs and campaigners.Â To this end the major focus of the Osborne plan has been to reduce government spending so that the nation can pay its debts.Â To this end money has been poured into banks, to encourage them to lend and stimulate business, while the UK has seen the deficit fall by a quarter even as the flow of credit has failed to restimulate an economy headed for a triple-dip.
Itâ€™s no coincidence that the countryâ€™s woes remind those with long memories of the chaotic, strike-stricken and economically sluggish late 1970s.Â The last time Moodyâ€™s withdrew its stamp of approval, the AAA credit rating, was then; Britain has held the highest credit rating possible since 1978.
But on the 22 February this year, Moodyâ€™s downgraded the UKâ€™s rating to AA1.Â Other rating agencies including Standard and Poorâ€™s and Fitch are expected to follow Moodyâ€™s lead over the next few months.Â In response the Chancellor told reporters that the change was a â€˜stark reminder of the countryâ€™s debt problem,â€™ and went on to say that it was an endorsement of the aims and methods set forth by the government when they took office: â€˜Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it.â€™
Moodyâ€™s described the reasons for the downgrade in a press release.Â They said that the â€˜key interrelated driversâ€™ of their decision were â€˜the continuing weakness in the UKâ€™s medium-term economic outlook,â€™ the certainty that the governmentâ€™s fiscal consolidation programme, billed to take only one parliament, would now â€˜extend well into the next parliament,â€™ and the UKâ€™s â€˜high and rising debt burden.â€™Â The Bank of England was also downgraded to AA1.
Responses from the Chancellorâ€™s own party have been mixed.Â Conservative ex-Chancellor Lord Lamont said, â€˜the message this sends out is that the fiscal consolidation is in the opinion of some people taking longer than expected.â€™ Speaking on BBC4â€™s World This Weekend, Lord Lamont said â€˜It is wrong to draw the lesson from that as being you ought to expand borrowing and moderate it even further.Â If anything, they are saying, â€˜You are going too slowly.â€™â€™
Lord Lamont speaks for a large section of the Conservative party.Â Other former government members have come forward to support the idea, expressed by former Conservative Chancellor Lord Lawson, that the â€˜basic thrustâ€™ of the Coalition policy was correct.Â Other Conservative voices called for more, deeper cuts.Â Conservative backbenchers called for cuts to corporation tax and capital gains to revive the flagging economy.
UK Government is borrowing too much
Their key arguments were ably put by Conservative backbencher Adam Afriyie, widely tipped to be a contender for the partyâ€™s leadership position. Â Mr. Afriyie said in the Mail on Sunday that â€˜for all the cuts and austerity, core government spending has been reduced by only 3% since May 2010â€¦ What we need are bold, simple, serious measures to secure growth right now.’
He was echoed by John Redwood who told the Sunday Times that â€˜the markets have been saying for some time that the Government is borrowing too much.â€™
Vince Cable, the Coalitionâ€™s Business Secretary, told BBCâ€™s Andrew Marr Show on 24 February that the downgrade was â€˜largely symbolic,â€™ adding that the ratings agencies were â€˜like tipsters; they get some things right and a lot of things not right.â€™Â Crucially, Mr. Cable referred to those calling for faster deeper cuts as â€˜right-wing ideologues.â€™
The government, it seems, is unlikely to make significant deviations from its present course â€“ assuming George Osborne survives politically.Â In Parliament on 25 February Shadow Chancellor Ed Balls called him the â€˜downgraded Chancellor,â€™ recalling John Smithâ€™s description of John Major as a â€˜devalued leaderâ€™ in the aftermath of 1992â€™s Black Wednesday.Â Currently, Mr. Osborneâ€™s opponents in his own party have consisted of some who have urged him to greater cuts on the records, and others who have personally criticised him anonymously.Â The risk to his political career will come when those critics go on the record.
Damage to the Economy
The principal danger thatâ€™s associated with the loss of the AAA credit rating is damage to the economy as the country faces rising credit costs, particularly interest rates, and weakening currency.
Mansoor Mohi-Uddin of UBS writes that â€˜the pound is undergoing a sharp devaluation against the other currencies.â€™Â However, while the pound saw some losses over Monday and has slipped to approximately 1% lower than its previous position against other currencies, the changes are not disastrous and the chances are good that the influence on currency markets will be minimal.Â CMC Marketsâ€™ Michael Hewson told Radio 5 on 25 February that â€˜this is a political sideshow rather than an economic sideshow.â€™ Â The poundâ€™s fall had begun before the downgrade â€“ there was a 10 US cent drop in the value of the pound between the start of 2013 and Moodyâ€™s news.
To the degree that there has been a direct economic effect it has been a self-stoking effect on sovereign debt, which has weakened since the downgrade as British gilt bonds saw a slight rise in yields, a measure of the interest rate on the bond.Â However the effect of foreign investors will be to offer a reward in the form of increased yields with one hand and punish with the other, in the form of reduced currency worth.Â Investors make more pounds, but theyâ€™re worth less.
Impact on the Housing Market
The most serious effects will come when the higher interest rates are passed down to consumers.Â In a housing market characterized by â€˜stratified lockoutâ€™Â – where potential renters cannot afford rent and potential buyers cannot get credit for mortgages â€“ the new growth seen over 2012 could be undone if interest rates push the cost of borrowing beyond first-time buyers, an effect compounded by the modest rise in house prices seen in the first month of this year.
Lessons from the French and the U.S…
In considering the likely effects we can look to case studies in France and in the US, which lost the Standard and Poor AAA rating it has held since 1941 on August 5 2011.Â In the US, markets suffered and there was a fall in international trading but the economy and the housing market have actually improved significantly since then.Â Meanwhile in France, there has been no disastrous drop in the price of houses or in the national economy.Â The real world consequences of the downgrade itself seem small.
The effects are more likely to be political than anything else.Â Whatever knock-on effects are seen on markets are likely to be caused by events in government rather than by investors learning news they have been expecting for weeks anyway.
In government, Mr. Osborne has been accused of evasive circular logic: Ed Balls said the Chancellor had â€˜gone in a weekend from saying we must stick to his plan to avoid a downgrade, to saying that a downgrade means we must stick to his plan.â€™Â In fact, Moodyâ€™s prediction that the Coalitionâ€™s fiscal consolidation programme would â€˜extend well into the next parliamentâ€™ will be put to the test next year.Â The likelihood that Labour will make political capital out of the downgrade that will be meaningful at the next election is strong and that is likely to be the greatest effect of the loss of the rating to which Mr. Osborne once pinned his political credibility.
About the Author:
This article was written by Les Calvert, who is the Director of Property Abroad and Homes Abroad and often writes articles and guides on buying international property. His 300+ websites feature over 250,000 properties for sale in more than 100 countries around the world. Visit his site at: Property-Abroad.com.
Photo credits: James via Flickr