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Juice left in economic policy despite triple-A downgrade

The UK’s rating downgrade is a long way from being Osborne’s 1992 Norman Lamont and the ERM moment

HOISTED BY HIS OWN PETARD or much ado about nothing. Either of these might be the verdict on Moody’s downgrading of the chancellor and his policies. The issue is important primarily because George Osborne said it was and made keeping the triple-A the first of eight benchmarks for judging whether the government was delivering a new model of economic growth. The economic consequences, however, could well be far less significant than the political, simply because of the elevated status the chancellor has been giving to maintaining the AAA rating.

The downgrade to Aa1 was not really a surprise – early warnings had been given and some adjustment had been factored into the market’s pricing. The agency justified its decision with the continuing weakness in the UK’s medium-term growth prospects and ‘the high and rising debt burden’, which are of course inter-related problems. Slower than predicted growth will make both the tax and spending numbers much worse. To soften the blow, however, the Moody’s statement did say that, on its current course, the UK will eventually regain its AAA status – but only by continuing on the same economic path.

Although their analyses are given a high profile, the rating agencies do not have an unblemished record. The big three are Standard and Poor’s and Moody’s, which have about 40% of the market, and the smaller Fitch agency. Their role is to provide independent assessments of the creditworthiness of bond issuers, companies or countries, which can have an influence on the cost of raising funds. A top rating is also a validation of a government’s economic policy.

Many criticisms can be made of the ratings agencies. They are taken too seriously and do not always agree with each other, a consequence of being players in the market as well as judges of it. They had an appalling record before 2009, and their sloppy analyses of loan packages made the credit crunch even more severe. The absurdly fine calibrations they use are difficult to relate to real-world distinctions in creditworthiness and it is hard to believe the likelihood of defaulting can be reduced to one number. In their defence, it has to be said that assessing countries is easier than analysing the bundles of sub-prime loans they rubber stamped as triple A up to 2009 since most country information is in the public domain.

For the major countries, the rating seems little more than a virility symbol. When France and the US were downgraded, the impact was close to zero. Nobody believes either of those countries will default and their borrowing costs remained largely unchanged. And the world did not stop turning in the aftermath of the UK downgrade.

For several years, the UK has been able to borrow at historically low rates, of about 2%. Nobody knows whether this was due to the triple A rating. It might have been because we were seen by markets as a sound economy which always paid its bills and had a government that was pursuing the right debt-reduction policies. Perhaps Osborne believed too much in the agencies’ view and was not confident enough in the markets’ ability to judge what was going on. 

From the text accompanying Moody’s numbers, it is clear there is little comfort for the government’s opponents. Even more of the same is needed, rather than the sort of U-turn favoured by the shadow chancellor. This is not to say Ed Balls is wrong to want growth as the way out of the mess – so does Osborne. The issue is how to achieve it and, in Moody’s opinion, piling more debt on top of debt is not the right route.

The noise will be played out in the political arena rather than in the real economy, although sterling might wobble a bit, adding to inflationary pressures. For Osborne, this is a long way from being his 1992 Norman Lamont and the ERM moment, still less his 1976 Denis Healy and the IMF debacle. The indecision in Italy is of much more concern to markets.

Dennis Turner is the former chief economist at HSBC

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