UK government debt outlook cut from stable to negative by US credit rating agency Fitch: What it means – and does it matter?
- Fitch became the latest agency to raise concerns about the outlook for UK debt
- The credit rating agency warned of ‘significant increase in fiscal deficits’
- The move puts further pressure on the cost of debt as borrowing rises
The outlook for UK government debt was slashed from ‘stable’ to ‘negative’ by Fitch yesterday as the New York credit rating agency reacted to the Chancellor’s ‘unfunded fiscal package’.
Fitch cited the Government’s ‘weakened political capital’ in justifying the change, warning that Kwasi Kwarteng’s poorly received mini-budget could lead to a ‘significant increase in fiscal deficits over the medium term’.
The agency also pointed to the absence of an independent Office for Budget Responsibility forecast and an apparent clash with the Bank of England’s strategy to fight inflation.
Fitch said: ‘The government’s weakened political capital could further undermine the credibility of and support for the government’s fiscal strategy’
Fitch said: ‘Although the Government reversed the elimination of the 45p top rate tax… the Government’s weakened political capital could further undermine the credibility of and support for the government’s fiscal strategy.’
Just a few days earlier, Fitch’s rival Standard & Poor’s threatened a credit downgrade on UK debt after assigning the country a ‘negative outlook’ in the wake of Kwarteng’s fiscal event.
The late September mini-budget precipitated a plunge in the value of sterling against the US dollar and caused the yield on government bonds – gilts – to soar, the latter of which required Bank of England intervention after it led to a potential crisis in the pensions market.
While Fitch and S&P maintained their credit ratings at AA- and AA, respectively, the change in outlook is another headache for the Government as the move weighs on investors’ perception of the riskiness of UK debt and therefore the compensation they demand in return for buying it.
Fitch, S&P and Moody’s are the three big credit rating agencies, charged with assessing how likely a borrower is to repay debts.
This information is used to help those buying or selling existing debts, such as gilts.
If a country has its rating downgraded, it means the ratings agency has slightly less confidence that it will be able to pay its existing debts, most likely because it believes the country’s economic outlook has weakened.
A country that has its rating downgraded can see its cost of borrowing rise – lenders will want a higher rate of interest to match the increased risk.
Bonds and prices
In simple terms, when a country borrows money it issues bonds, which global investors buy in exchange for regular and reliable income from the issuing nation.
These periodic interest payments are called coupons.
Bonds are issued at a price known as par – for example £100 – with a set coupon paid over their duration and capital invested repaid at the end.
These bonds can then be traded on secondary markets, and their price can rise or fall above or below their par value.
The price of a bond has an inverse relationship to the yield paid.
When bonds are out of favour and trade below their par price, the buyer is purchasing the coupon payments at a discount and so their yield rises.
Vice versa if bonds are in high demand, they may trade above their par price and their yield will fall.
The UK had its credit rating cut in 2017 by Moody’s – by three notches – from AAA to AA2, after Theresa May’s government rowed back on the austerity drive of former Chancellor George Osborne.
At the time, Moody’s also highlighted the economic risks that leaving the European Union posed to the world’s fifth-biggest economy.
Gilts sold off again on Thursday, bringing two-year, five-year, 10-year and 30-year yields to 4, 4.3, 4.1 and 4.3 per cent, respectively, by midday.
Gilt yields remain below their levels in the immediate aftermath of the mini-budget but are well above where they have been for most of this year, having started 2022 hovering at around 1 per cent.
Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said: ‘The Prime Minister’s [Conservative Conference] speech yesterday had nothing new to reassure markets and with political divisions widening within her party of how to pay for big tax cut promises, ratings agencies are far from impressed.
‘Fitch followed S&P to cut the outlook on the UK’s AA investment grade rating to negative from stable.
‘This matters because even without a downgrade the UK’s borrowing costs have risen sharply, and if the ‘stable’ rosette is ripped off, foreign creditors are going to demand even more money to fund the government’s growing debt pile. Moody’s has also warned that large unfunded tax cuts risks damaging the country’s debt affordability.’
Streeter added that gilt yields are ‘creeping higher again’ despite the BoE’s intervention and, if they continue to climb, the bank ‘may have to dive back into bond buying’.
Head of investment at Interactive Investor Victoria Scholar said: ‘There are serious concerns about the government’s unfunded stimulus measures and what the increased levels of borrowing will spell for the UK’s inflationary conundrum as well as its debt levels down the line.
‘The UK is already dealing with historically high debt levels in the aftermath of the pandemic when billions were spent on expensive emergency programmes such as the furlough scheme, track and track and the vaccine roll-out.’