Even the pessimistic analysts had given Britain until September to lose its AAA rating. That it has happened now, before the Budget, shows just how fast things are moving. Moody’s has tonight downgraded Britan from AAA to AA1 and has also told us why.
Don’t expect economic hell to break loose as a result: these ratings tend to follow, rather than lead, the markets. But this is politically devastating for George Osborne, given that he has asked us to judge him by the preservation of this rating (and made it a manifesto pledge). So what went wrong?
1. The markets now doubt that Osborne has a credible debt strategy. The below graph, released earlier today from Citi, shows how things have gone pear-shaped. It shows debt as a share of GDP, which has risen as growth has evaporated. The green line shows how Osborne first promised to handle the debt. The dark blue line is how it’s now likely to go. The failure of this thick blue line of debt to level out, let alone descend, is why the credit rating agencies are so worried.
Moody’s is not as pessimistic as Citi, and expects UK debt to peak at 96pc of GDP in 2016*. But that’s still bad enough to trigger an early downgrade.
“Given the pace of deficit and debt reduction that Moody’s has observed since 2010, there is a risk that the UK government may not be able to reverse the debt trajectory before the next economic shock.”
2. Osborne’s St Augustine strategy: shifting the pain ever-further into the future Moody’s statement refers to:-
“…the government’s fiscal consolidation programme, which will now extend well into the next parliament…which necessarily makes their implementation less certain.”
This is a reference to what James Forsyth has called Osborne’s St Augustine approach to austerity: “Lord, let me balance the books – but not yet.” In the below graph, the pink shows the proportion of fiscal tightening to be enacted by whoever is Chancellor after 2015 (and the bookies believe it’s unlikely to be Osborne). Each bar represents a Budget or Autumn Statement and shows how Osborne’s resolve has weakened pretty much every time he has stood up in the Commons to make a statement. We’re now at the stage that just over 50pc – ie, the majority – of the pain is being deferred until after the election.
Osborne knows that Labour unlikely to call him out out this. Ed Balls is fixed on a false narrative: cruel, harsh cuts. He’ll never admit that core spending (ie, stripping out debt and dole) is rising under Osborne: it destroys his line of attack. The media tends to reflect the debate between the parties. So if Labour isn’t making a fuss about core spending rising under Osborne, then no one will notice. Except those pesky rating agencies.
3. Britain is seeing the worst recovery in history. Moody’s says that, in the old days, we sprang back. This time: not so much. Making debt artificially cheap is not, it turns out, much of a growth strategy. It has this to say:-
“The country’s current economic recovery has already proven to be significantly slower — and believes that it will likely remain so — compared with the recovery observed after previous recessions, such as those of the 1970s, early 1980s and early 1990s.”
It may as well have thrown in the 1930s because this is the…
Osborne’s strategy has been mainly rhetorical, not economic. Focus groups like to hear that the deficit has been cut by 25pc – not knowing this also means debt is up by more than 25pc. The Prime Minister talks about “paying down Britain’s debts” and Osborne talks about “dealing with the debt” giving the clear impression that the debt is falling. This works – politically, at least. Polls show just 6pc of the public realise that debt is rising. But 100pc of the credit rating agencies know the real picture, which looks like this:-
Moody’s says it has not given up on Britain and its analysis is full of flattering references. AA1 is still a very respectable rating. Also remember that Britain – unlike Greece – has its own central bank which is able to print as much money as the government wants to spend. So if the markets don’t want to buy all Osborne’s IOU notes then the Bank of England will gobble them up (and we all pay the price via higher inflation/pension shortfalls).
America’s borrowing costs actually fell after its downgrade, so Moody’s thumbs down may not inflict actual financial harm. It’s fairly clear that, somewhere along the line, Osborne decided to take this hit, rather than try to find greater savings in government budgets. (His cuts total just under 1pc a year right now, hardly harsh or deep. But he does have an election to think about, and believes that deeper savings would hurt the Tory Party’s chances.)
One thing is for sure: Osborne will make fewer references to taking the British economy “out of the danger zone” because this is precisely where Moody’s thinks we now stand.
* Moody’s also notes that the UK debt would have been even higher had it not been for Osborne’s recent Masterchef manouvre where he bagged £37bn of QE cash
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