This was trailed as “Fitch warning could prompt a Plan B” and leads on from my report of Fitch’s warning in “Final warning at the 11th hour” of 11/11/09
This is how it could all go wrong if nobody wakes up in time - or Brown decides to ignore it.
Christina
NB Not on web so retyped and E&OE
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TELEGRAPH 13.11.09
Ratings agencies will not tolerate the EU’s fiscal mess indefinitely
Tracy Corrigan
Can you hear as faint clunking sound ? It is the sound of the credit ratings agencies rattling their sabres.
Earlier this week David Reilly, Fitch’s co-head of global sovereign ratings caused a little shudder in the gilts market when he warned that the UK could lose its AAA rating, if the next government fails to bring spending under control and reduce debt. He also said another fiscal stimulus package would put the rating under threat.
The substance of this is not new but by dint of repeating these concerns the agency is making itself crystal-clear: the AAA “stable” rating the UK still enjoys (from both Fitch and Moody’s) cannot be taken for granted.
The UK’s fiscal position is dire. When the IMF warned last week of the further fiscal weakening of advanced countries. it noted that Japan, Ireland, Spain and the UK are projected to require the largest adjustment. “This underscores the need for governments to announce credible exit strategies now, even if it is premature to begin exiting from fiscal support,” it added
Unfortunately the UK doesn’t really have a plan as such, and there is no great optimism that the Chancellor, Alistair Darling, is poised to put one in place in the pre-Budget Report scheduled for December 9th.
So far the ratings agencies have given the UK the benefit of the doubt. They recognise that there is little likelihood that the country’s fiscal problems will be tackled ahead of next year’s election.
But such forbearance will not continue indefinitely . Already Standard & Poor’s, another ratings agency has changed the outlook for the UK’s AAA rating to negative; S&P’s AAA ratings of Australia, Austria, Canada, Denmark, Finland, France, Germany, Netherlands, Norway, US, Sweden, Switzerland and Singapore all remain stable. In June the agency explained that “in light of the challenges to strengthen the tax bases and contain public expenditures, the UK debt burden could approach 100 pc of GDP by 2013 and remain near that level thereafter. The rating could be lowered if we conclude that, following the forthcoming general election, the next government’s fiscal consolidation plans are unlikely to put the UK debt burden on a secure downward trajectory over the medium term.”
In other words all the ratings agencies are waiting until after the election to see what happens, and the assumption, so far, is that the fiscal position will be knocked into shape. It is a fair assumption, if only because the alternative is so horrific,but it is not a given, particularly in the event of a hung parliament. But the ratings agencies could lose patience before that, particularly if the government tried to borrow still more money to stimulate the economy before the election.
This limits the Chancellor’s room for manoeuvre in the pre-Budget report. Or at least I hope that it does. Because there is real danger of market crisis.
Even without these worries on the fiscal front, the gilts market is likely to have a rockier time next year as quantitative easing (QE) draws to an end. According to HSBC the Bank of England;s gilt purchases under the QE programme account for around 90 pc of gilts issuance in the financial year 2009-10. Unfortunately all these gilts will have to be sold back into the market at some point in the future, and that overhang is likely to push prices down, particularly if it coincides with rising short-term interest rates.
However, just as QE purchases subside, banks are likely to start buying gilts in large quantities in order to meet new liquidity measures which are being phased in globally to reduce risk in the banking system. Fortuitously enough for the British government, the Financial Services Authority is proving to be the most proactive regulator in its enforcement of these requirements. HSBC reckons that, assuming these measures are implemented, banks could purchase as much as 60 pc of gilts’ issuance in the next fiscal year. “Bank demand for gilts . . . is likely to siphon off a large proportion of supply over the next few years at least” according to Andre de Silva, HSBC strategist.
A downgrade would change that dynamic, but such technical support would not help much in the event of a full-blown crisis of confidence in the UK’s ability to service its debt.
“We have no choice about whether to tighten fiscal policy” says Michael Saunders, UK economist at Citigroup. “it’s a question whether we do so before or after a crisis.”
If the ratings agencies threw in the towel, the result would be a spiral of lower ratings, higher borrowing costs and unstable market conditions, possibly leading to rate hikes which in turn might delay economic recovery. That is not an inevitable consequence: a downgrade by a single notch could give the government a big enough kick to prompt rapid and drastic action. Let’s hope it does not come to that.
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