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HomeDorset NorthThe Economics Story: …Credit Ratings & Other Myths

The Economics Story: …Credit Ratings & Other Myths

Fortnightly insight into the current state of the economy and how it relates to Dorset by Nigel F Jump, Chief Economist of Strategic Economics Ltd (a Dorset Company) and Visiting Professor in Economics at the Universities of Bath and Plymouth.

See: www.strategiceconomics.co.uk

The irony of Moody’s decision to downgrade the UK credit rating from AAA to AA1 is how much media and political fuss it caused and how little the ‘professionals’ cared. For economists and the financial markets, the indecisive Italian election and the passing of the US budget deadline without resolution were far more important. The rating change told us nothing we did not already know whereas the other factors added fresh uncertainty. 

According to Reuters, Moody’s said UK growth was likely to be sluggish due to a mix of weaker global economic activity and a drag “from the ongoing domestic public and private-sector de-leveraging process.  This period of sluggish growth poses challenges to the government’s fiscal consolidation program, which we now assume will extend well into the next parliament”.  Oh, really – didn’t see that coming!  Talk about driving through the rear view mirror! Two points are relevant:

1.  What took you so long?

The credit agencies should have cut the UK’s rating (and many others) in 2006/2007 and again in 2010/11.  Any credit scoring system should be based on current trends and how they might move forward, i.e. based on an objective, proactive assessment of future risks.  Instead, the credit rating agencies have become backward looking, reactive bodies.  Maybe, now is the right time to re-assess UK prospects and downgrade but, because no action was taken as things deteriorated before the 2008 credit crunch and nothing has been done in the 4+ years of downturn since, they are well behind the curve.  

2.  What does it mean?

The main effect will be that the UK will have to pay a bit more for it’s borrowing and this may encourage the sterling depreciation that is already underway (at least, against the dollar).  Gilt yields should rise and their prices should fall.  Some investors won’t like that, but gilts are already very over-priced and, like the rest of us, bond holders need to take some pain if a viable recovery is ever to get underway.  

Yields are still only just above 2% (10-year) and with inflation staying above that for the foreseeable future, bonds are losing money in real terms.  A recovery to a ‘normal’ yield curve would see such rates closer to 5.5%.  It will be years before we get back there but, for a sustainable, well-functioning recovery, the current situation is untenable.  If the Moody’s downgrade starts a process of adjustment towards a better assessment of risk and return, we may all yet cheer.

Finally, at the latest MPC meeting, the soon-to-leave Governor of the Bank of England voted for more gilt purchases and the soon-to-arrive Governor has indicated a willingness to engage in further, a similar monetary stimulus.  I fear they are facing the wrong way too.  

Some of the recent business surveys suggest a bit more confidence is evident.  Without further shocks, the real economy may start to move forward.  The monetary authorities, the markets and the credit raters should be planning for that recovery.  Perhaps, the stock market already is. I think some indication that the next move at the short end of the yield curve will be upwards might actually help business and investor sentiment towards the future.  

Professor Nigel Jump, 2ndMarch 2013

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