UK Rating Still AAA Though Outlook is Revised to Negative

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One week before UK Chancellor George Osborne is scheduled to deliver the new budget, Fitch Ratings has revised its outlook for the UK’s long-term Issuer Default Rating (IDR) downward from stable to negative. The announcement has provoked a quite a number of responses, such as “UK Chancellor George Osborne has been issued a pre-Budget warning” and “Fitch has warned that UK is more likely than not to lose its coveted AAA rating,” and “Britain’s hopes of retaining its prized triple-A credit rating were dealt a blow last night” that may or may not reflect what the Fitch Report was actually saying. Tough economic times can become a catalyst for sensationalising reports such as this one by Fitch, especially when the subject is a sovereign government and when any portion of the news is somewhat negative. Even as it appeared that 30-year gilts were falling as a result of the report, a representative of Investec Plc observed that “Fitch is only stating what we all know, but highlighting it is causing a bit of the weakness in the gilts.”

What the Report Said

The Fitch report actually presented fairly positive insights and implied that the British government is properly managing its finances during these difficult times: “Fitch Ratings has affirmed the United Kingdom’s foreign currency IDRs at ‘AAA’ and ‘F1+’. Fitch acknowledges the progress made by the UK in reducing its structural budget deficit. That being said, the UK has very limited fiscal space to absorb further adverse economic shocks, thus warranting the Outlook revision to Negative.”  It is, therefore, important to understand that the substance of the report affirms that the government is approaching the economic situation in a practical manner. The problem as identified by Fitch is if the UK is or will be well positioned for the long term, with respect to potential pressure from the European and global economy on its own.

Note the following positive statements from the actual Fitch report:

“The affirmation of the UK’s ‘AAA’ ratings reflects the progress made in reducing the government’s structural budget deficit and the credibility of the fiscal consolidation effort. The UK’s ‘AAA’ rating is underpinned by a high-income, diversified and flexible economy as well as political and social stability. The UK sovereign credit profile also benefits from the macroeconomic and financing flexibility that derives from independent monetary policy and sterling’s status as an international ‘reserve currency’.”

“Fitch judges the government’s fiscal consolidation plans to be credible, reflecting the strong political commitment and institutional capacity.”

“The mix of tight fiscal and ‘loose’ monetary policies allowed for by the flexible monetary and exchange rate regime, including ‘quantitative easing’ (QE), is supportive of the necessary rebalancing of the UK economy.”

“Combined with an average maturity of government debt of over 14 years – around double that of its ‘AAA’ peers and a rating strength – on current policies the risk of a fiscal financing crisis is assessed to be negligible.”

In Fitch’s opinion, the credibility of the government’s fiscal commitment was “further enhanced” by the government’s major budget announcements in the Fall of 2011.

It is important to understand that the report reminds readers that, although the outlook is negative, the country still retains a AAA rating.  The report said that the governement’s deficit reduction plans are credible and that projected future debt levels were “consistent with the nation retaining it’s AAA status.”

Why then a Negative Outlook?

Fitch explained that the negative outlook is based on “the very limited fiscal space left to absorb future financial shocks” resulting from unexpected adverse economic conditions.” Fitch’s concern is linked directly to its opinion that the “Eurozone debt crisis has significant implications in the UK” and that “the crisis is not resolved and could once more intensify.”Clearly advocating current government budgetary restraint, the report also cited concerns that the government could decide at some time to implement “discretionary fiscal easing” that could put the UK into a critical debt situation.

Government Responses

Mr. Osborne told reporters that “this is a reminder of why it is essential Britain sticks to its plans to deal with its debts. As Fitch itself says, the reason we are keeping our triple A rating is because of ‘the progress made in reducing the government’s structural budget deficit and the credibility of the fiscal consolidation effort’.”  He underscored the government’s fiscal policy, saying “This is just another warning to anyone who believes there can be deficit-financed giveaways.”

Danny Alexander, Treasury Chief Secretary, said “There will be no unfunded giveaways in next week’s budget. This is a salutary reminder as to why Britain needs to deal with the enormous debts and deficits we inherited, why we have got to stick to those plans. It should be a wake-up call to anyone who thinks we can afford, as a country, to loosen the purse strings. We can’t afford to do that.”

A Final Observation

The negative outlook will remain in place until it is reviewed again in 2014. It indicates only a “slightly great that 50% chance of downgrade over a two-year horizon.”

Fitch Ratings Press Release

↑ Irish Examiner
↑ The Telegraph
 Business Week
 Fitch website

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