Britain’s AAA credit rating reaffirmed, but what difference does it make to investors?

7th October 2011

S&P reaffirmed the UK's AAA credit rating saying that its ‘diversified economy', ‘flexible fiscal and monetary policy' should enable it to weather the economic storm coming from the Eurozone. In an added endorsement for Osborne's policies, the rating agency suggested that one of the few risks to the UK's rating would be a government pull-back in its austerity measures.

This article is a good summary of the S&P move. The news is encouraging, not least because until relatively recently the UK's AAA-status was seen as substantially at risk. This MSNBC article from August suggests that those countries most at risk of losing the top rating were France, Finland, Austria and the UK.

In early August, Moodys warned that the UK could lose its rating if it pulled back on its spending reduction plans. A year ago the situation was even worse as markets worried about a hung parliament and the effect it would have on austerity plans.

What has changed? It is certainly not the economic outlook for the UK, which – as S&P itself admits – is ‘sluggish'. It predicts growth of 1.8% between 2011-2014, below the Office for Budgetary Responsibility estimates of 2.5%. Nor is the UK out of the woods. S&P was clear that the Government's reliance on private sector growth was optimistic at best. 

S&P's assessment appears to be based on two things : The first is that while the UK is in a difficult situation, it has been among the first to implement austerity measures and it has reasonably widespread support among the general population for those measures. The second is that it has strong long-term demand for its government bonds. S&P has said: "We view the UK as having deep capital markets with strong demand for long-dated gilts by domestic institutional investors.

"There is also demand from non-residents for sterling-denominated UK government debt, which provides some diversification to the UK's investor base."

The rating agency move has had no effect on sterling in the short-term, which remains at around €1.15/£1. This, to some extent, is good news¸ given that any appreciation in sterling could threaten the UK's anaemic growth. Equally, it has not done a lot to raise fund manager expectations of UK investment.

Quantitative Peter on the Telegraph site is typical of many in the comment boards when he says: "So the UK hangs on to AAA credit rating…I wouldn't get too excited. These are the same guys who said subprime mortgage derivates were "investment grade". On the same site sircomespect believes that the news is nevertheless, encouraging: "Where other major and previously thought 'stable' countries are being downgraded. 

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