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.