UK AAA rating loss – stark reminder of debt problems or humiliating blow?

The credit ratings agency Moody’s has downgraded the UK economy from AAA to Aa1, the first time it has lost its top rating since 1978.

The downgrade was the result of expectations economic growth in the UK will “remain sluggish over the next few years”.

Moody’s also pointed out significant “challenges” ahead for the government’s debt reduction programme.

Naturally, the downgrade has divided political opinion.

Speaking for the government, the Chancellor George Osborne described the move as “a stark reminder of the debt problems facing our country”.

He explained that it added resolve “to deliver our economic recovery plan, this decision redoubles it”.

Shadow chancellor Ed Balls described the decision as a “humiliating blow to a prime minister and chancellor who said keeping our AAA rating was the test of their economic and political credibility”.

Osborne risks becoming known as the “downgrade chancellor” as a result of the news.

So is the downgrade a stark reminder of our national debt problems or a humiliating blow for the government and its austerity programme?

What consequences will the downgrade have for investors?

It will be interesting to see how the equity and currency markets react to the news when they open for business in the morning.

We expect the decision to have been priced in to the markets, to a large extent.

We have known for some time that one of the main ratings agencies was likely to downgrade the UK at some point this year. Timing wise, this has happened a little sooner than expected; we at least thought they would wait to see what additional growth and austerity measures would be announced in the Budget next month.

Sterling is likely to be hit harder than the FTSE 100, in our opinion.

What really matters is the relative strength of the UK credit rating compared to alternatives for investors.

The UK remains very much a ‘safe haven’ for gilt investors.

By downgrading our credit rating, Moody’s is unlikely to have had much of an impact on the cost of borrowing for the UK.

When the US lost its AAA credit rating last year, it did not experience much change to its borrowing costs. Ditto for France when Moody’s removed its AAA rating in November.

We could see gilt yields rise marginally on the back of this news, although the news last week that the Bank of England is considering additional QE should keep yields suppressed.

Politically, this is bad news but not a crushing blow for the coalition and its austerity strategy.