Written by Alice Payne
Posted on 29/06/2016

Why the UK’s credit downgrade matters

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The UK has been stripped of its top AAA credit rating by all three of the world’s main credit rating organisations. Following the UK’s decision to leave the European Union (EU), Moody’s, S&P and Fitch all downgraded the country’s creditworthiness, driven by concerns about its economic and political stability. So how will these changes affect the UK?

Credit concerns

Last Friday, Moody’s was the first to cut the UK’s credit rating outlook from stable to negative. Fitch also lowered its rating from AA+ to AA and, on Tuesday, S&P reduced the UK’s creditworthiness from AAA to AA. 

This is the first time the ratings agency has ever reduced an AAA sovereign rating by two notches. Explaining its rationale, S&P cited concerns about the “wider constitutional issues for the country as a whole”. It continued:

“The negative outlook reflects the risk to economic prospects, fiscal and external performance, and the role of sterling as a reserve currency, as well as risks to the constitutional and economic integrity of the UK if there is another referendum on Scottish independence.”

Meanwhile, speaking on how the UK’s vote to exit the EU had influenced its decision, Moody’s said:

“In our opinion, this outcome is a seminal event, and will lead to a less predictable, stable, and effective policy framework in the UK.”

The impact of a credit downgrade

These credit downgrades indicate how the UK’s creditworthiness is viewed by international investors, which may now make it more difficult for the government to borrow. The higher the credit rating, in principle, the lower the interest rate. Although UK government bonds will likely still be considered a safe investment, this outcome compounds a challenging period for the UK’s financial markets and the economy. 

Market volatility

The political and financial turbulence of the last few days, heightened by a leadership vacuum, has created significant volatility in the markets. 

The pound fell to a 31-year low and, despite the Chancellor’s attempt to restore confidence, the UK’s biggest companies lost £40 billion in value.  

Indeed, two of the UK’s banks experienced such a drop in share price that trading was suspended. Barclays’s share price fell by 10.3% while RBS’s dropped by 15%, precipitating an automatic halt in trading. 

The FTSE 100 performed better than many had expected on Monday. However, the multinational companies in the index are typically less affected by the British economy than the smaller companies of the FTSE 250. Considered a better indicator of UK business health, on Monday it reached a 52-week low of 14,951.46.

The economic outlook

So what lies ahead for the future? Sterling is struggling on the foreign exchange markets, economists have further reduced UK economic growth forecasts and the central bank may cut interest rates to a new historic low in order to stimulate the economy. Mark Carney has said the Bank of England is “well prepared” and ready to inject an extra £250 billion into the UK’s economy. But will it be enough?

Fitch forecasted an “abrupt slowdown” in short-term growth and weaker growth prospects in the medium-term, while S&P raised concerns about “a deterioration of the UK’s economic performance, including its large financial services sector”. With the rating agencies on standby to make further downgrades, the UK’s creditworthiness – and economic prospects – may yet fall further. 

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