Did the recent move higher in UK bond yields trigger the switch to "negative outlook" by Fitch ratings agency?

15th March 2012 by Shaun Richards

As today is the 15th of March let me point out that it is the day that we should Beware the Ides of March! Although for the UK Chancellor of the Exchequer such worries maybe came early as the ratings agency Fitch joined Moody’s in putting the UK’s AAA credit rating on negative watch. As the news came in I have to confess I immediately wondered if the leak about issuing a 100 year Gilt (government bond) was a spoiler for this news. Governments do get told early about such developments and even if it was just before the 24 hour notice period I wonder if it leaked.

What did Fitch have to say?

Often statements from ratings agencies make some good points.

The revision of the rating Outlook to Negative from Stable reflects the very limited fiscal space to absorb further adverse economic shocks in light of such elevated debt levels and a potentially weaker than currently forecast economic recovery.

There is nothing particularly earth shattering there as a weaker economy does present a problem for us reducing our fiscal deficit. Also Fitch goes on to make a point that the media often confuses.

against the backdrop of a still large structural budget deficit and high and rising government debt

Whilst we are making some forward progress with our deficit we are only reducing the rate at which our national debt grows not reducing it outright.

There were also areas where Fitch could have done a better job. For example using “structural budget deficit ” as a measure is a mistake on two counts I think. Firstly it is virtually impossible to measure and secondly as it is invariably lower than the actual deficit it is used by politicians and others much more than it should be. I would not be surprised to see countries aim to fix their structural budget deficit and then discover that it has been measured wrongly.

Also I found this bit of the report slightly odd.

sterling’s status as an international ‘reserve currency’.

Is it? I am not so sure.


The painful truth is that the UK is no longer a AAA credit risk. One could make a case for arguing that in the “expect the unexpected” world in which we now live no country at all should have such status. However the UK’s fiscal deficit whilst falling is still high and any further economic slow down would pose a severe challenge to its further reduction. So as ever the ratings agencies are off the pace and should have reduced our rating a while ago. In the end they will get around to it which will no doubt create a media storm but may affect markets very little because in reality we are not a “AAA” nation.

The UK does get some protection by its ability to set its own interest-rates and because it has its own currency. But the more thoughtful will have spotted that we have deployed both weapons ( a falling pound in 2007/08 and heavy cuts in base rates to 0.5% and then holding it there for 3 years) and the results at best are mixed. So they are weaker weapons that might have been assumed a few years ago.

UK Gilt prices are falling and yields are rising

I pointed out yesterday that US government bond yields had risen recently and that this was posing a challnge to the latest form of monetary easing which is called Operation Twist. This was supposed to reduce longer term interest-rates or bond yields and for a while it did. However the rise in yields has continued and the US ten-year yield has risen to 2.33% which is a sharp rise as it was briefly below 2% as recently as Monday afternoon.

The UK has not avoided a world wide rise in yields driven mostly by the US move. The ten -year gilt yield has now hit 2.40% and in price terms it has fallen from 117 as of late Monday to 114.15 as I type this. At the same time the Bank of England was buying some £3 billion of UK gilts as part of its Quantitative Easing programme but as you can see by the price moves it did not help much.

If this turns out to be a general reversal of the trend for lower bond yields then several problems are posed. So far we have risen just under 0.5% in yield terms from the lows of mid-January 2012.

1. Variable mortgage rates were rising anyway and may now be joined by a rise in fixed rate mortgages.

2. The Bank of England will be making losses on it most recent gilt purchases and further falls in price could push it towards a loss overall.

3. It will be more expensive going forwards to finance the UK’s national debt.

4. The only potential gain is for savers who may see some better deals offered.

Sometimes particular events turn out to be a signal of a change and I wonder if the potential hubris surrounding the discussion of a new 100 year (or even a perpetual..) gilt did actually signify a change in the way that stop-loss orders often do? We will have to wait and see as bond yields had fallen substantially from the levels seen even a year ago when our ten-year yield was just over 1% higher.

It is perhaps somewhat ominous to consider that the last year (which turned out to be much weaker than hoped) was the recipient of a bond yield boost and gives a possible grim theme to 2012 if we should see the reverse. Also if you are wondering about the timing of Fitch’s move how about higher bond yields triggering it in a reversal of the normal consensus?

Problems in Eastern Europe?

The European statistics agency Eurostat has released its hourly unit labour cost figures for the last quarter of 2011 and I spotted these numbers which are comparisons with the year before.

Bulgaria +12.6%, Romania +8.6%, Hungary 6.6% and even the usually well-behaved Estonia is at +7.2%.

As I have a number of readers in these countries I would be interested in their thoughts on this subject. On its own it looks a little ominous for future economic developments.

The Swiss Franc

There has been a small amount of relief on this subject as it has moved below 1.21 versus the Euro ahead of the latest Swiss National Bank meeting which has now taken place. Plainly markets were afraid of more currency intervention and now this has passed I will be following it to see what develops.




13 thoughts on “Did the recent move higher in UK bond yields trigger the switch to "negative outlook" by Fitch ratings agency?”

  1. JW says:

    Hi Shaun
    Can I suggest two possible reasons for edging up of UK bond yields;
    1 The Fed has been slow in giving more sugar-rush to the market, keeps talking down QE3, so US longer dated yields are going up.
    2 German longer-term yields are edging up as people realise that as LTRO helps the weaker nations to get their monds away, the Germans are paying with real money transfers of now over €400bn.
    Eventually , we will catch up with the cans.

    1. Anonymous says:

      Hi JW

      One of the ironies is that bond yields should have been going up for a while but have instead lived in a Quantitative Easing inspired false market.

      To add to your list maybe some investors are starting to get the hint that inflation is being more persistent than many have claimed and that real yields are mostly highly negative except at the longer maturities…

      1. JW says:

         Shaun, I think the problem is that almost everything is a ‘false market’ at the moment. Its difficult to see anything that isn’t overtly manipulated. Yes Inflation is there, adding to general ‘Fear’ about Oil and the Iranian situation.

  2. Anonymous says:

    We will have to watch if these yields carry on rising. Have you seen the talk of release of some of the US and UK’s strategic oil reserve? I didnt know we were getting that desperate!

    Does the UK even have a strategic reserve?

    1. JW says:

       Hi Josephine
      I think the US release is to do with ensuring gas doesn’t reach $5/gallon before the election. However with Iran looming its dangerous, unless they know there is going to be a collapse in price before the rebound upwards.

      1. JW says:

         Update, a White House spokesman has just refuted the story. However oil prices dipped on the first story…testing, testing.
        Related news, SWIFT has taken all Iranian banks off their system which isolates them from normal international transactions. With the majority of the active US Fleet in the Gulf within the week, something may be about to happen.

        1. Anonymous says:

          Perhaps aircraft carriers are like London buses and they like to flock in threes, or perhaps not……

  3. ChrisLongs says:

    UK budget soon – in light of your comments above any thoughts on Gov. action/inaction?
    Who would buy these perpetual bonds with almost certain losses with ongoing inflation etc.

    1. Anonymous says:

      Hi Chris

      I expect some action in the pension sphere. As someone who has worked in that area I continue to despair at the way governments of all the main hues in the UK feel that they can keep meddling with the system and not destroy it! Since A Day in 2006 there have been a torrent of changes and promises not kept. They did however remember to boost the MPs pension scheme in the middle of the last decade…

      As to your second question one mightb wonder who does buy UK bonds at recent levels apart from the Bank of England and those who have risks to hedge like annuity providers. With prices above and often way above 100 there are guaranteed losses at maturity.

  4. Anonymous says:

    Hi All,
    Just sang to some folk gathered to raise funds for recently bereaved children. Smiling faces, no talk of Iran oil, gilt yields and inflation. I noticed just a little stress on the faces of those under 60s. Over 60s seemed to be more at ease.Interesting.

    To Fitch, in November they reacted negatively to the Autmn statement – something about forecasts being over optimistic and Osborne running out of fiscal space. I think you are right, inflation is recovering its significance – the counterfactual fades away as an excuse.

    1. Anonymous says:

      Hi Shire

      The Financial Times is making a similar point this weekend that the over 60s are facing austerity with less problems than say the 20s. I do think that the youngest are particularly hurt by it. If we look at youth unemployment there are problems before we get to places like Spain where it has ballooned. Also I suspect that they are likely to be getting jobs with less security and lower pay as many older workers are locked into better contracts ( I am generalising here and of course there are exceptions). So I would say that there are several groupings or sub-sets.

      Are you a good singer as you mention “Smiling faces” ? Either way a mention of recently bereaved children does put other problems into perspective does it not?

      1. Anonymous says:

         Hi Shaun
        I enjoy a good song or two and I think my Welsh ancestry helps !

  5. Anonymous says:

    Hi Shaun,

    In regards to the reported Bulgarian labour costs – I’d question the accuracy and relevance of them. Much of the construction sector gets paid the minimum wage with cash in hand top ups – the rest work only cash in hand. Much of the public sector get paid very poorly (about 300 euro per month) and find ways to earn brown paper envelopes of undeclared cash. However educated professionals like software engineers earn quite well because they can easily immigrate to the US or Western Europe. (maybe 2000 euro per month)

    Secondly I expect Bulgarian wages to rise in comparison to Western Europe because they are very low in absolute terms. It would takes many years of 12% increases for the minimum wage of 150 euro per month to catch up with Western Europe let alone exceed it.

    Thirdly, construction workers wages are lower now than in 2008 due to reduced demand.

    And some of the big employers with political connections treat their workers terribly. I heard a story that a copper mine owned by the same guy from Lukoil Bulgaria – was 6 months late on salaries. The economy minister threatened to put him out of business within a month if the salaries were not paid. Next a big scandal blew up with the economy minister who was forced to resign. You could not make it up.

Leave a Reply

Your email address will not be published. Required fields are marked *