What happens if the UK’s credit rating is downgraded?

The UK is at risk of having its credit rating downgraded because of last week’s tax-cutting mini-budget.

Moody’s credit rating agency said the measures announced by Chancellor Kwasi Kwarteng last Friday would “permanently weaken the UK’s debt affordability”. In a statement, it said that the “large unfunded tax cuts are credit negative” and will “lead to structurally higher deficits amid rising borrowing costs, a weaker growth outlook and acute public spending pressure”.

The statement, together with the International Monetary Fund’s warning that Liz Truss’s new government should “re-evaluate” its planned tax cuts, has “piled more pressure” on Kwarteng, said Reuters, particularly following the pound’s record slump last Friday. Moody’s, which has left the UK’s sovereign credit rating unchanged thus far, did adjust its 2023 growth forecast for GDP from 0.9% to 0.3%.

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What is a sovereign credit rating?

Sovereign credit ratings are analyses provided by independent firms to indicate the relative credit risk attached to investing in the debt of a particular country. The three most notable credit rating agencies – Standard & Poor’s, Moody’s and Fitch Ratings – all assess the economic and political environment of a country to issue a rating, essentially advising investors on how likely it is a nation could default on its bonds.

What is the UK’s current rating?

According to Moody’s, the UK is currently rated Aa3, defined as “obligations judged to be high-quality and subject to very low credit risk”. That in essence means it’s easier and cheaper for the UK to borrow money.

The UK was last downgraded by Moody’s in 2020 from Aa2, when the agency cited Brexit trade deal uncertainty, higher borrowing through the pandemic and weakened institutions and governance as the leading reasons for its decision.

How does the UK compare to other nations?

• Aaa is the highest rating Moody’s gives: Germany, US, Australia, Denmark and Canada are among those with the top rating.
• Belgium, Cayman Islands, Czech Republic, Hong Kong, Isle of Man, Macao, Qatar and Taiwan are countries with the same credit rating as the UK.
• Southern European countries generally have a lower rating than northern European nations, according to Moody’s, with Spain rated Baa1, Portugal Baa3 and Italy Baa3.
• The lowest-rated countries include Venezuela and Lebanon (both C), and Russia and Argentina (Ca).

What will a downgrade mean for the UK?

When the UK was last downgraded, Ghulam , professor of finance at Keele University, wrote for The Conversation that a cut to a country’s rating “should prompt a sell-off in their sovereign bonds and drive up borrowing costs for the government”. He said, however, that low inflation and low-interest rates would mean the downgrade would “not have any impact on the UK’s ability to borrow” at that time and that Moody’s “assessments are not as relevant as they once were”.

The landscape looks much different now, and even without a downgrade the UK’s current borrowing cost was rising at an “alarming rate”, said The Guardian, with the prospect of increasing interest rates and already high inflation.

That prompted the Bank of England to intervene today, by buying long-term government bonds, essentially lending the government money, in order to lower borrowing costs. It will offer “some respite from a financial storm” but means the government must “revise its tax-cutting plans” to avoid more turmoil.

A downgraded credit in October could exacerbate the situation still further, said financial services company ING. It said last week that “investors will take great interest in what the rating agencies have to say about UK fiscal plans”.

What has the reaction been?

Much of the reaction to Moody’s statement has been linked to the unusual IMF intervention into a G7 country’s fiscal plans.

Bloomberg News called the statements a “stinging rebuke” to the government’s tax cuts, while The Guardian said it was “sharp criticism” and the government was seeing a “growing international backlash” to its plans.

The IMF and Moody’s statements “spooked traders”, said Yahoo Finance. Today saw the FTSE 100 “touching a 17-month low” amid “renewed pessimism” over the UK’s economic outlook.

The statement from the IMF, in particular, prompted a response from the Treasury, which said it had “acted at speed to protect households and businesses through this winter and the next” and is “focused on growing the economy to raise living standards for everyone” with plans for a further budget to be published in November.