December 3, 2023

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Yesterday, Fitch downgraded its outlook on the UK government debt from ‘stable’ to ‘negative’ as the New York credit rating agency reacted to the chancellor’s ‘unsecured budget package’.

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Fitch cited the government’s “weakened political capital” to justify the change, warning that Kwasi Kwarteng’s poorly received mini-budget could lead to “a significant increase in the budget deficit over the medium term.”

The agency also pointed to the absence of an independent forecast by the Office of Fiscal Responsibility and a clear contradiction with the strategy of the Bank of England to combat inflation.

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Fitch said: “A weakening of the government’s political capital could further undermine confidence in and support for the government’s fiscal strategy.”

Fitch said: “While the government has repealed the 45p top tax abolition…weakening the government’s political capital could further undermine confidence in and support for the government’s fiscal strategy.”

Just days earlier, Fitch rival Standard & Poor’s threatened to downgrade the UK’s debt credit rating after giving the country a “negative outlook” on the Kwarteng financial event.

The mini-budget at the end of September accelerated the fall in the value of the pound against the US dollar and led to a sharp rise in government bond yields, the latter of which required intervention by the Bank of England after it led to a potential pensions crisis. market.

While Fitch and S&P have maintained their credit ratings at AA- and AA respectively, the outlook change is another headache for the government as the move affects investors’ perception of the riskiness of UK debt and therefore the compensation they demand in exchange for the purchase. . It.

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Fitch, S&P and Moody’s are the three major credit rating agencies tasked with assessing the likelihood that a borrower will repay debts.

This information is used to help those who buy or sell existing debts such as gilts.

If a country’s rating is downgraded, it means that the rating agency has slightly less confidence that it will be able to pay its existing debts, most likely because it believes that the country’s economic outlook has deteriorated.

A downgraded country could see borrowing costs rise as lenders want higher interest rates to match higher risk.

Bonds and prices

Simply put, when a country borrows money, it issues bonds that global investors buy in exchange for regular and reliable income from the issuing country.

These periodic interest payments are called coupons.

The bonds are issued at a price known as par, such as £100, with a set coupon paid over the life of the bond, and the capital invested is paid at the end.

These bonds can then be traded on the secondary markets and their price can rise or fall above or below their face value.

The price of a bond is inversely proportional to the income paid out.

When bonds are out of favor and trading below their face value, the buyer buys coupon payments at a discount, and so their yield rises.

Conversely, if bonds are in high demand, they may trade above their face value and their yields will fall.

In 2017, Moody’s downgraded the UK’s credit rating by three notches from AAA to AA2 after Theresa May’s government abandoned former Chancellor George Osborne’s austerity policies.

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At the time, Moody’s also highlighted the economic risks of leaving the European Union for the world’s fifth largest economy.

Pigs sold off again on Thursday, resulting in 2-, 5-, 10- and 30-year yields of 4%, 4.3%, 4.1% and 4.3% respectively by noon.

The gilt yield remains below its level just after the mini-budget but is significantly higher than it was for most of this year as it hovered around 1% in early 2022.

Suzanne Streeter, Senior Investment and Markets Analyst at Hargreaves Lansdown, said: “The Prime Minister [Conservative Conference] yesterday’s speech contained nothing new to calm the markets, and with the growing political division within her party over how to pay for big tax cut promises, the ratings agencies are far from impressed.

Fitch, following S&P, downgraded the outlook on the investment rating of the UK AA from stable to negative.

“This is important because even without the downgrade, the UK’s borrowing costs have skyrocketed and if the ‘stable’ outlet is derailed, foreign lenders will demand even more money to finance the government’s mounting debt. Moody’s also warned that large unfunded tax cuts could hurt the country’s debt affordability.”

Streeter added that securities yields are “rising again” despite intervention from the Bank of England, and if they continue to rise, the bank “may have to go back to buying bonds.”

Interactive Investor’s head of investment, Victoria Scolar, said: “There are serious concerns about the government’s unfunded stimulus measures and what increased borrowing will mean for the UK’s inflation puzzle as well as its debt levels going forward.

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“The UK is already dealing with historically high levels of post-pandemic debt, with billions spent on costly emergency programs such as the layoff scheme, tracking and tracing and vaccine deployment.”