U.K. Is Stripped of Triple-A Rating


February 23, 2013/  By Matthew Walter, Cassell Bryan-Low And Charles Forelle / WSJ

Moody's Investors Service MCO +1.69% stripped the United Kingdom of its triple-A credit rating, predicting economic weakness will weigh on public finances for years to come.

Moody's lowered the U.K.'s domestic and foreign-currency bond rating one notch to Aa1 and changed its outlook to stable. It is the first of the three major ratings firms to do so, though both Standard & Poor's Ratings Services and Fitch Ratings have the U.K. on negative outlooks.

The move by Moody's is a psychological blow to the United Kingdom, which is fiercely proud of its historical position on the world stage and keenly attuned to signs of its diminishment. It is also a political blow to Prime Minister David Cameron and his chancellor of the exchequer, George Osborne, who has long justified his painful government spending cuts on the grounds that he is maintaining the U.K.'s triple-A rating.

The U.K. economy fell early and hard in the financial crisis, and it has had substantial trouble recovering. Many economists believe a "triple-dip" recession is in the offing, and Moody's alluded to "sluggish growth" persisting into the second half of the decade.

The government and the central banks have thrown an arsenal of fiscal and monetary weapons at the problem, including low interest rates and a program meant to restart stalled bank lending to the troubled economy. Little has worked. Meantime, Mr. Osborne has pushed to trim the U.K.'s gaping budget deficit.

"We expect the country's debt will continue to grow in coming years," said Bart Oosterveld, managing director in charge of Moody's sovereign ratings group, in an interview. "In our central scenario, we don't expect the country's debt burden to stabilize until 2016."

Credit-ratings agencies had been warning for months that the U.K.'s top rating was in danger. Speculation about a possible downgrade had been percolating in the markets for the last week. That helped drive the pound down Thursday to a 31-month low against the dollar. Slipping after the downgrade, the pound ended Friday trading at $1.5163.

"As more and more members get kicked out of the [triple-A] club, the marginal impact on the currency is less," said Gabriel de Kock, head of U.S. foreign-exchange strategy at Morgan Stanley MS +3.29% .

The U.K. is unlikely to see meaningfully higher borrowing costs as a result of the Moody's move; its bonds have benefitted for several years from investors' flight away from troubled euro-zone countries and toward European nations with stronger economic fundamentals, or who issue their own currency. The Bank of England's robust quantitative easing program, in which it purchases government bonds, has also helped hold bond yields down and keep a lid on borrowing costs.

Messers. Osborne and Cameron had made retaining the triple-A rating one of their priorities when they took power in 2010. Since then, the U.K. economy has barely grown.

More recently, however, Mr. Osborne has downplayed its significance. In December, he told a parliamentary committee that although losing the rating "wouldn't be a good thing," it was only one test of the U.K.'s economic policy. "The ultimate test is what you can borrow money at."

Late Friday, he issued a response to the downgrade, saying he planned to stick to his austerity plans. "Tonight we have a stark reminder of the debt problems facing our county," he said. "Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it."

Mr. Osborne blames the U.K.'s problems on debts built up over many years and the crisis in huge neighbouring euro zone, which accounts for a large portion of U.K. exports.

Mr. Osborne is due to present his annual budget on March 20.

The Moody's decision was based on "the increasing clarity that, despite considerable structural economic strengths, the U.K.'s economic growth will remain sluggish over the next few years," Moody's said. "The country's current economic recovery has already proven to be significantly slower ..Moody's believes the risks to the growth outlook remain skewed to the downside."

The sluggish pace of the U.K.'s economic recovery has made it more difficult for the government to shore up its finances, and Moody's says it now expects the country's general debt level to peak at just over 96% of gross domestic product in 2016. The U.K.'s high and rising debt burden has left the country more vulnerable to future economic instability, which is unlikely to reverse before 2016, it said.

The move follows similar high profile cuts in recent years. In November, Moody's also downgraded France from its top rating. In August 2011, Standard & Poor's cut the U.S. credit rating from AAA. S&P also downgraded France and Austria in January 2012.

Fitch Ratings and Standard & Poor's Ratings Services both have triple-A ratings on the U.K. with negative outlooks.

In its statement, Moody's also highlighted uncertainty about how that the government's fiscal consolidation plan will be implemented since Mr. Cameron's administration announced that the program will have to be discussed by the next parliament.

As a result of the slower-than-expected economic recovery, higher debt load and political risks, the government's ability to absorb any future economic or financial shocks has been limited, Moody's said.

"There is a risk that the U.K government may not be able to reverse the debt trajectory before the next economic shock or cyclical downturn in the economy," the ratings agency said.

Moody's expects that a combination of political will and medium-term fundamental underlying economic strengths will, in time, allow the government to implement its fiscal consolidation plan and reverse the U.K.'s debt trajectory.

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