What Britain’s downgrade means for your money

It finally happened. Britain has lost its ‘cherished’ AAA credit rating.

Credit rating agency Moody’s took the leap on Friday night. It’s the first of the ‘big three’ agencies to do so. But it won’t be the last.

You might think: “So what?” We’re hardly in junk territory. The US was downgraded ages ago. And at least we managed to hang on to our AAA rating long enough to wind up the French.

Yes, it’s embarrassing for George Osborne. But the markets have already priced this in. There’s nothing to worry about.

That’s the view that most pundits are taking.

But I wouldn’t be so blasé. This matters more than most people think. Here’s why…

Britain’s central bank is panicking and its politicians are desperate

Moody’s has dropped Britain’s AAA-rating by one notch, to AA1. In short, the ratings agency thinks that growth is going to be weaker than it had expected. As a result, it’ll take longer to cut down Britain’s debts. Overall, higher debt and slower growth leave Britain more vulnerable to “adverse economic or fiscal shocks.”

It’s nothing we didn’t already know. It was always clear that the government’s growth forecasts were too optimistic. The fact that the ratings agencies are only catching up now shows how essentially pointless they are.

The Lex column in the FT even jokes that this is “good news for the UK”. After all, when the US lost its AAA rating in August 2011, US Treasuries rallied. And France hasn’t collapsed yet either.

In fact, the only AAA-rated countries in the G7 now are Germany and Canada, and they’ve both got their own problems. Canada has a huge housing bubble that’s about ready to pop now that their central bank head Mark Carney is leaving for the UK. And Germany – well, it’s on the hook for everyone else in the eurozone, so that AAA rating might not last either.

So the AAA badge itself is pretty meaningless.

But sadly, that doesn’t mean we can just shrug this off. When the US was downgraded, people panicked and bought the safest asset they could think of – which happened to be US government debt. When France was downgraded, it was just one of many problems afflicting the eurozone. In both cases, markets had bigger fish to fry.

The timing for the UK is rather less fortuitous.

Investors might have been getting to grips with the idea that UK growth will be pitiful for years to come, and that debt will be higher. But they are only just starting to grasp the implications of that.

The last couple of weeks have represented a major turning point. First we learned that the Bank of England expects higher inflation, and plans to do nothing about it. Then, we found out that Sir Mervyn King – who has previously shown decidedly mixed feelings towards quantitative easing (QE) –  actually voted for more this month. (He was outvoted by his other members for only the fourth time ever).

In other words, not only is the Bank tolerating inflation – it’d be happy to risk encouraging it in the hope of spurring a bit of growth. That smacks of desperation. And King’s inconsistency on QE smacks of panic.

This is a problem, to put it lightly. As I noted earlier this month, much of this is about confidence. A panicky central bank chief and an increasingly desperate government do not make for confidence.

In fact, as Alice Ross and Ralph Atkins point out in the FT, the man who tries to flog our gilts to buyers – Robert Stheeman, head of the UK debt management office – is clearly feeling a bit twitchy. “I read with interest some comments made by policy makers because it is all about confidence. The confidence of overseas investors is crucial to what we do.”

In other words – “thanks a million, Merv, for making my job ten times harder”.

In this context, the Moody’s downgrade matters. Osborne staked his reputation on maintaining the UK’s AAA-rating. So losing it has a significant political impact that it didn’t have in the US or France. It will encourage Osborne to go for broke to achieve even an illusion of growth. It certainly promises to make the Budget in March an even more fraught affair than usual.

Investors are becoming less forgiving

The other major issue is that investors suddenly have other options. For the last few years, the UK has seemed like a ‘least-worst’ bet when compared to the instability of Europe, the turmoil in the Middle East, and the constant dollar-eroding efforts of the Federal Reserve.

But much of that is changing now. And it’s leaving the UK a lot less attractive by comparison. For example, while Mervyn King is flailing around like a headless chicken, the US is starting to mutter about ending QE. It might not happen tomorrow. But even talking about it is a major mental readjustment for markets.

Indeed, our own regular writer James Ferguson, co-founder of the MacroStrategy Partnership, thinks that QE in the US could stop as early as the middle of this year. You can find out more on why he thinks this, and what the impact could be, in the current issue of MoneyWeek magazine. If you’re not already a subscriber, get your first three copies free here.

In short, with better options around, as Japanese bank Nomura put it: “Markets are becoming less forgiving”.

The pound is now at a two-year low against the dollar. It’s already fallen below the $1.53 ‘red zone’ highlighted by my colleague Dominic Frisby at the end of last month. There’s still plenty of room for it to fall further – as John Authers notes in the FT, judged by ‘purchasing power parity’, the pound’s fair value is around $1.45.

As Jeremy Warner puts it in The Telegraph, the sell-off in the pound “could easily turn into a full-blown rout if foreign investors start to lose faith in the value of sterling assets. This would force a steep rise in interest rates, a fiscal crisis, and another deep recession.”

That’s not so different to the argument we make in our End of Britain report – if you’ve not seen it, read it here. As for our investment advice, it’s the same message we’ve been hammering home for the last few months – diversify away from sterling, and avoid gilts.

And if you fancy taking a punt on sterling falling further, but don’t want to spread bet, you could buy the ETFS Short GBP Long USD (LSE: USD2) exchange-traded product. Keep a close eye on it – it’s not as risky as spread betting, but it’s still high risk, and it’s not a ‘buy and hold’ investment. But if the pound has further to fall over the next few months – and I suspect it has – it should do well.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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  • chris

    Is this not good news for the majority of investors whom have taken sensible investment advice?

    Most good investment professional will have little of no gilts and would have a high weighting to overseas stocks. The overseas stocks will i mmediately increase in value for sterling investors . Also the FTSe should do much better as 70% of earning are overseas and when this translates into sterling it will increase earnings and corporate profits.

    As long as people understand that all the imported food and goods will eventually go up in price (just dont buy all that supermarket junk food!) then most good investors will see this as great news

  • Romford Dave

    You’ll be accused of spreading more doom and gloom amongst the readership John, regardless of the truth behind the article.

    Unfortunately some have got it into their heads that debt isn’t a problem and more debt is even less so.

    God knows why they think that, maybe it’s because we print our own currency and can easily meet any liability, which of course is true assuming those creditors are willing to accept ever worthless paper.

    Time will tell of course if those pushing Balls as a solution are right, personally I think their talking bollox and have positioned accordingly.

  • Lumino

    Sterling weakness is headline news across mainstream media. And moneyweek says short it now?!

    Oh no wait…

    *If* the pound deteriorates then the short sterling fund *should* do well”. Genius. Keep the brilliant investment tips coming.

  • Guy

    > Sterling weakness is headline news
    > across mainstream media. And moneyweek says short it now?!

    To be fair to Moneyweek, they have been be saying “short sterling” for months now.

  • James

    Lumino – No one knows what the future holds.

    MoneyWeek is far more in tune with what’s really going on than most mainstream economic publications. Their advice is worth what they charge for it – namely nothing if you don’t have a subscription.

    ;-)

  • Lumino

    @Guy sorry, I wasn’t clear on that – I meant that if it’s in the media, there’s a significant danger it’s already in the price. I wasn’t suggesting they’d waited until now…

  • Bob

    Surely another recession will give them the excuse they want to keep a ZIRP? I cannot see anything – even the collapse of Sterling – causing them to raise interest rates.

  • Enlightened Patriot

    Thanks for a great report and when you come to say `Let us show you how to preserve your wealth’, I would respond with a recommendation to concerned people to read the Guide to Investing in Gold and Silver by Micheal Maloney (as I am currently doing, bought on Amazon for £11-69) and Google `Reasons to Buy Silver’ just as a start to set you on the right path. I am currently investing at least 10% savings in a precious metals portfolio as I see it as a once-in-a-lifetime opportunity to get back at crooked bankers and politicians whilst hopefully preserving some long term financial security before tshtf. Stocking 6 months of preservable food/drink is my next move.

  • dr.zeus

    Well following Romford Daves comments I do think John is part of the doom and gloom brigade. Of course I agree the government haven’t done nearly enough to cut the deficit and we cannot borrow our way out of this situation. However to be objective we should look at the £/$ rate over the last 25 years, and actaully what is happening is that we are comming back to a more normal trading range for stirling of 1.45-1.65. The real anamoloy was the rate in the latter years of the Brown/Blair era when rates reached $2.00/£. It didn’t feel like the end of the world in 1985,1986, 1993,1994, 1995, 2000, 2001,2002, & 2003 when the rate was at a simmilar level.

  • optimus prime

    welfare state of mind has to go period. thats the only way the UK can start reducing debt.. failure to do so you are on your own.

  • mim

    @10
    You mean the welfare state of socialising all the bank losses so that their chiefs can earn huge bonuses right?

    Try looking up the pyramid to see where the wealth is being funnelled into.

  • Derek P

    @11

    I agree completely, why is everyone always coming down on the welfare lot, 13billion is nothing compared to the 400 billion money printing thats gone to socialising the bank losses and increasing bonuses. Doesn’t make sense does it or maybe it does..

  • JT

    A good article, which also serves to illustrate how investing is now becoming a hostage to politics as much as economics and markets. Three quotes from Moody’s:

    “The UK’s creditworthiness remains extremely high” partly because of its “strong track record of fiscal consolidation”.

    “Slow growth of the global economy” is cited as the first reason by Moody’s for the downgrade.

    Moody’s praises the UK’s “fiscal policy commitment” but warns of a further downgrade if there is a “reduced political commitment to fiscal consolidation”.

    You won’t hear Ed Balls quoting any of this of course…

  • jackanory

    JT
    “a hostage to politics”

    I think this sums up this whole mess

  • Boris MacDonut

    #10 optimus prime. You have a poor grasp of what has just happened,possibley due to reading the Daily Mail and such like. Moody’s downgraded the UK to the third most highly rated nation on Earth because the Eton toffs have failed to engender any growth….not because of our debt and not because of any welfare largesse, because the Tories won’t spend enough to get the economy moving. I am dumbstruck how these so called educated people can be so stuck in a rut. Ideology has outdone common sense here, to everyone’s cost. Flipping useless failures.

  • Winston

    The UK is officially screwed. Now that the financial services industry is in decline. All we produce are teenage mums, chavs and One Direction pop music. Sell the pound, buy Norweigian kronor.
    Lets hope Argentina invade the Falklands or Spain has a crack taking Gibraltar. We need a conflict to drive the economy, take the people’s attention away from the economic woes and expend the chavs as cannon fodder. Win win
    Viva la Chavtannia of the waves

  • jackanory

    winston,

    I think your right, it will end in war, but this time Germany will be the cooler and will finally put it’s demon’s to bed
    or
    As I hope, our goverment WAKES up!

  • Boris MacDonut

    #16 Winston. Patriotic to the point of being closed-minded.With less than 1% of World population we somehow command 22% of its pharmaceutical industry, 18% of the aerospace industry, 10% of defence technologies,three of the largest ten oil and gas companies and a huge banking and insurance sector, perhaps the largest in the World. We are world leaders in high quality tailoring, luxury cars,michelin resturants, film and music, tourism and university education.We have one of the highest standards of living, literacy and life expectancy on the planet. But folk like you only seek to whine about the tosh you read in the Daily Mail. Britain isn’t screwed,but your mind has been twisted.

  • jackanory

    Borris,
    It seemed to me that your agreed with JT (for a change)
    and we need to have peope like Winston to have a different way of thought.
    Not everything is logical, otherwise all following this site would all be rich and intrest rates would be at 7%

  • Romford Dave

    Everything Boris says is true, if you accept that the world beating British companies he speaks of are largely foreign owned, the banking sector is effectively bankrupt, as are half the brokerages doing business at Lloyds of London, our Universities are geared up for foreign students bringing valuable funds faculty’s are desperate for and we have more people below the poverty line than our nearest neighbours, most of which are cursed by a life expectancy they can ill afford.

    The quality tailors are Jewish, the restauranteurs French (if you exclude the sweary one and the naked one who ply their trade in the US) and filming has come to an abrupt halt since the removal of luvvies tax breaks.

    We are doing well in the music stakes, not that will make one jot of fiscal difference as you download your mix mash of sound via the biggest US tech company’s latest gadget.

    On the bright side, the quintessentially British nature of the closing sequence of ‘Life of Brian’ should help.

  • Romford Dave

    I intended to say half the brokerages were owned by foreign based owners rather than that they were bankrupt.

    Apologies to all you flush and possibly flushed underwriters out there.

  • Bill

    Yes, Winston’s right, there’s plenty in need of a good war or two……..
    Certainly Spain can take Gib in a day or two, closely followed by the Argies grabbing their Malvinas…..
    but it’ll solve our problems too. Everyone can be mobilized instantly and no silly human rights questions asked. CO’s can be sent to work in the forestry.
    We are an offshore islandnd and, as such, are expendable. Even the US don’t need an Aircraft Carrier off the EU that much. We’ve just nationalised our banks and handed over our law to the EU, which is constructed just like the old Comintern, which the Soviets abandoned years ago when they re-located to Berne.
    Come on, you guys, just surrender, like you did at Singapore in 1942.

  • JREwing

    Once more than half the population is living off the state, it is game over – as some have helpfully pointed out above.

    Well, all I can say is that the productive ones that choose to stay in Britain will be taxed in ever more draconian fashion until (as a famous Chancellor once said) the “pips squeak”. By way of contrast, I pay around 15 percent income tax in total in Hong Kong. In the UK, it would be several multiples of that (not to mention capital gains tax and a whole raft of other taxes which don’t even exist here).

    I love Asia.

  • Andy

    Quote #15 Boris MacDonut
    “Moody’s downgraded the UK to the third most highly rated nation on Earth because the Eton toffs have failed to engender any growth….not because of our debt and not because of any welfare largesse, because the Tories won’t spend enough to get the economy moving.”

    I could only agree with this comment if the Tories were to cut significantly in the public sector to spend in the private sector. They won’t of course, they wouldn’t even know where to start spending! Although tax cuts would be a good start.
    I totally disagree Boris that it’s ‘not because of our debt’. The debt is the fiscal drag that is stopping us from moving foward, and our foreign creditors know it. Inflation cometh!

  • El tel

    @ JREwing

    the pips were squeezed a long time ago, there are no ‘pips to squeak’ anymore. This is why we have no growth, the printing presses are rolling, and a growing welfare state. Stick to Asia there are probably far better opportunities out there .

  • Jolly Roger

    22 Bill

    Singapore is a good one ! Though It seems to me that our current situation is more like ‘Carry on up the Kyber’. Our elite are quaffing caviar ( without added horsemeat ! ), pontificating, and listening to sweet violin music ( or maybe One Direction on their iPod ) before retiring for afternoon tiffin. Whilst all around them the house is collapsing. Yesterday’s credit rate downgrade was in most sections brushed off as a bit of a nuisance ( a bit of fiscal dandruff ) . Which may be right or wrong . But it is probably one of many cannon balls we are going to have to deal with in the coming years ( perhaps some more serious ) . Eventually some one will have to change the cine-reel but not before we have had to endure a damn good thrashing. This is the British way.

  • JREwing

    ere is little risk of HK experiencing the kind of, ahem, “currency situation” that the UK will soon experience. So yes, you are preaching to the converted.

    Re: the Rich, I think that Labour will win the next election. After that, even if there isn’t more tax to be squeezed from the so-called “rich”, they will jack up taxes anyway. It works extremely well with their voters. In half a decade or so, the UK will be lucky to have the current living standards of Portugal (at least the Portuguese have much better weather). Lousy weather and a sick economy make for an awful combination. I am glad I am out.

  • El Tel

    @ JREwing

    I have seen a microcosm of the future at a local level. Tories in, start cutting, industrial action, Tories chucked out, labour back in, even more cuts, plus across the board tax rises, mass disillusionment, apathy, every one looks for an alternative, or turns to weird religions.( sounds a bit like the 70’s doesn’t it ) It was once when we where in such a dire state that at least we did have a decent music and entertainment industry to distract us, but even that’s gone down the swanee. As for the ‘currency situation’ I think that there are many people who believe that this will be good because we can ‘export’ our way out of recession. This ignores the fact that most of our manufacturing base has been destroyed or has gone abroad. I think most sensible investors in the UK are beginning to wake up to the fact that we are entering another ice age, and the current recession is going to be a long hard one . Good luck in Asia !

  • JREwing

    @ El Tel – I agree with you. If currency devluation worked so well, the UK have been way more competitive than West Germany between 1945 and 1990. Britain had double digit inflation and a weak currency through the 1960s and 1970s whereas West Germany had the strongest currency on earth.

    This weak currency argument makes even less sense now given that labour costs are a tiny fraction of total manufacturing costs because of massive automation. For example, a Swiss watch selling for $20,000 in the international market costs $700 to produce (and labour is a small fraction of the $700).

    Automation means that it is the country with the lowest overall manufacturing costs (especially energy) that will perform best. Countries with dirt cheap labour, high taxes and expensive energy will do badly.

  • Boris MacDonut

    #24 Andy. Read Moody’s assessment. It does not mention debt. It majors on the lack of growth,like every other critic of the UK including the IMF.Without growth there is little hope of paying off any debt. Only UK based Tory media think the debt is a problem…….it is a symptom.
    #23.#27 &29 JR. Let’s hope you stay in Hong Kong.They deserve you. Let’s also hope you and none of your immediate family ever falls ill, has an accident or is need of education ,housing etc.. Smug twits tell us about what “I”can do and what “I” can get.We’re glad you’ve gone.

  • El Tel

    @ JREwing

    You make a very valid point. I am no expert on manufacturing but I have my suspicions that the problem with UK manufacturing is structural rather than much to do with currency. I seem to remember during the 89 – 95 recession British manufacturing being a quiet success story . This was not widly reported in the media because it is an unfashionable sector. When New Labour came in , the sector struggled again. This is probably because a lot of money which should have been earmarked for modernisation and investment was ploughed into the ‘fashionable’ housing sector. Excessive debt and inflation, also mean’t that productivity declined throughout the noughties.The canny Germans though steered clear of the housing boom and invested heavily in manufacturing firms . This is why I believe they have managed to weather the financial crisis better than us. And why we can buy cheap well made German manufactured goods in Aldi’s .

  • Boris MacDonut

    #31 El Tel. But the German Government is more indebted than ours . They weathered the credit crunch better because they had growth and increased state spending.

  • El Tel

    32 boris

    I didn’t know that. Are you really sure of this ? you have to remember that Germany is currently having to prop up half of Europe. It seems a bit far fetched that they are doing this solely because they have borrowed more money and increased state spending. They are not stupid, far from it.

  • JT

    El Tel – it’s important to remember that Boris frequently just makes stuff up.

    He has evidently not read the Moody’s report. He says it doesn’t mention debt. In fact, it talks a great deal about ‘fiscal consolidation’, which refers to the UK’s deficit (and of course our debt is essentially just the accumulation of deficits over time). As for the assertion that debt is the symptom rather than the problem, this is correct in that it’s a product of Gordon Brown running a deficit (i.e. overspend) of 3% throughout the top of the ecomonic cycle, gunning the economy to breaking point to fund welfare handouts and spending on such valuable projects as ID cards (£5bn p*ssed up the wall) and the NHS computer system (which had to be scrapped after 10 years of failure).

  • JT

    Boris – your comment to JR about not falling ill (presumably on the basis that paying only 15% tax must mean no-one can get access to healthcare) is just the sort of attitude which creates an environment where a body like Mid-Staffs NHS Trust can almost literally get away with murder. If you think the NHS is a marvellous example of why we need to tax so heavily, you really are a most incredulous fool.

  • JREwing

    @ Boris – Nice scare tactic. Won’t work with me. Here is a Wikipedia entry about Hong Kong:

    Hong Kong is one of the healthiest places in the world.[1] Because of its early health education, professional health services, and well-developed health care and medication system, Hongkongers enjoy a life expectancy of 85.9 for females and 80 for men,[2] which is the second highest in the world, and an infant mortality rate of, the fourth lowest in the world.[3][4]
    Hong Kong has high standards of medical practice. It has contributed to the development of liver transplantation, being the first in the world to carry out an adult to adult live donor liver transplant in 1993.[5]

    Let’s see the NHS do better than that.

    I have friends who are doctors who work for the NHS and even had a girlfriend who was a surgeon in a NHS hospital which shall not be named. I know all I need to know about the NHS and I am glad I am not paying for it or am at its mercy.

  • Andy

    I have to say I totally agree with everything you’ve said JT.

  • Boris MacDonut

    #33 El Tel. I’m sure. According to the World Bank, Eurostat and CIA German Government debt is 95.5% of GDP,the UK is at 91% and France at 88%. The actual total is much higher as Germany has a bigger economy.
    #34 JT. You just get more strange in your accusations. Of course I read the report. Sufficient to spot it mentions growth 12 times, but debt just 5 times. The top issue it cites is weak growth, the second is subdued medium term growth.It goes on to say “the main driver of the downgrade is sluggish growth”….and while “debt servicing capacity is VERY strong” it says the only way to recover triple A status will be rapid economic growth.

  • Boris MacDonut

    #36 JR .Let’s hope more folk like yourself up sticks and move to the fetid humid swamps of Southern China. Where you can stop moaning about paying fair taxes and helping the poor by just riding roughshod over the locals. A win/win situaution. We lose the moaning tax evaders and Hong Kong gains some.

  • El Tel

    @38 Boris

    Thanks for the clarification. Keep up the good work

  • Romford Dave

    Ever concious of the lies, damn lies and statistics caveat, do the percentages quoted above allow for the ever growing 270 billion pound gorilla in the room ‘private finance initiative’?

    I know it’s been much embraced by successive UK chancellors because of its off balance sheet qualities, as it has in many other countries, judging by this Wiki entry –

    “As well as the UK, PFI has also been adopted, under various guises, in many other countries including: Australia, Canada, the Czech Republic, Finland, France, Greece, India, Ireland, Israel, Japan, Malaysia, the Netherlands, Norway, Portugal, Singapore, Spain and the United States”

    Germany seems notably absent…..

  • JREwing

    @ 39 Boris – Be careful what you wish for.

  • Boris Macdonut

    #42 JR .What on earth do you mean? I am perfectly happy to lose the uncivilised types from our civilised nation. They will feel more at home in the barely civilised alleys of Hong Kong. i fear you intimate that we might miss them…….fat chance.

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