News Column

UK Downgrade Raises Specter of Lost Decade

Feb. 25, 2013

Neil Craven, Financial Mail on Sunday, London

Britain's debt downgrade has been branded a "humiliating blow" to the country that will hamper economic recovery, hit savers and lead to higher prices on the High Street.

The downgrade came late on Friday night and has raised fresh concerns of a "lost decade" for Britain's economy. It is expected to hit the markets on Monday morning as City traders respond to the decision by debt rating agency Moody's to cut Britain's gold-plated AAA grade.

City experts said many traders had already factored a downgrade into prices but that the ripple effects would still be felt on Monday.

It could hit currency markets, affecting those planning foreign trips, and may spread to other stocks such as consumer industries as the wider ramifications are felt.

"The FTSE 100 is largely made up of multinationals so the impact there may be limited. Traders will be looking to the FTSE 250 and beyond where the impact may be greater," said Richard Hunter, an equity analyst at broker Hargreaves Lansdown.

"However, the main effect will be in the currency markets and will pile pressure on the already weak pound. Traditionally when that happens it is good for exporters. But importing products becomes more expensive and that could feed through to consumer prices over the next few months."

He said the cut by Moody's was widely anticipated but will be sobering for the City because it confirms that a recovery is still distant.

Sir Martin Sorrell, chief executive of advertising giant WPP, said the downgrade was "emblematic" and illustrated the problems facing the UK economy. "I think it's a stark reminder of what we're going through, the shifts in economic power away from Europe and how long it will take to get things right," he said.

"The Lehman crisis and its forerunners were so serious it has already taken five years to get where we are. We really do face a lost decade economically."

But he insisted the Government should "hold its course" on its economic recovery plan.

However, TUC General Secretary Frances O'Grady slammed the plan as "completely in tatters." She urged Chancellor George Osborne to change course.

"This downgrade is a humiliating blow for a Chancellor who has staked his reputation on the UK's triple A credit rating. The fact that economic stagnation, rather than current borrowing levels, has caused this downgrade proves that demand-sapping austerity is ultimately self-defeating," she said.

"The Chancellor needs to start prioritising growth and jobs over pleasing ratings agencies."

Helen Dickinson, director general at the British Retail Consortium, said: "What is key for the Government is to support hard-pressed consumers. Priority should be given to both boosting confidence in the wider economy and easing pressures on household budgets."

A spokesman for investment company Fidelity said the impact of losing the rating is less severe amid widespread global economic weakness.

He said: "With only Germany and Canada now boasting an AAA rating, the stigma of losing the top-notch rating is much reduced. When the US lost its AAA its cost of borrowing actually fell as investors continued to see it as a safe haven."

"However, the reasons for the downgrade -- persistently low growth and the reduced ability to deal with any future economic shocks -- are likely to weigh on the pound. It fell by a cent against the dollar on the news and is likely to fall further. It might be worth getting your summer holiday foreign currency now."

Chief economist Jeremy Cook at forex broker World First said the re-rating was "overdue' and that the UK had been "living on borrowed time" with its AAA rating.

"Last week these pressures intensified and sterling hit a 16-month low on Wednesday after extremely gloomy contents of the Bank of England's Monetary policy Committee minutes were revealed," he said.

Sterling was likely to remain weak in the long term but paradoxically the announcement may bring short-term stability.

Cook said: "Moody's announcement has now eliminated one short-term uncertainty. I wouldn't be surprised if sterling ended this week higher." But he added: "For those travelling in the next week or two, it may help to stagger forex purchases to reduce the risk of wild swings in sterling's value."

There was some relief on mortgage rates with the Government's Funding For Lending Scheme continuing to keep home loan costs down.

Ben Thompson at Legal & General's mortgage division said: "Markets have expected this and there should not be much disruption. Cheap funds are at the ready, so mortgage rates should continue to remain low."

Brian Dennehy, managing director at investment adviser FundExpert also cast doubt on the effectiveness of the recovery strategy.

"The downgrade merely confirms what everyone has known for a long time -- the UK is fundamentally weak and austerity isn't working to get debt down," he said.

"UK savers and investors must ensure they use this downgrade as a time for reflection. The reality for savers is stagflation and deposit rates are guaranteed to be negative in real terms, probably for years to come. The impact on sterling is just beginning and it is a trend I believe will persist for a year or two.

"But that creates opportunities for UK investors. At the most simple level it gives a kicker to investments you hold overseas.

"But that doesn't have to be overseas stock markets. For example, simply buying dollars will be effective. Some analysts, and we sympathise with them, believe we will end up at parity with the dollar."

It seems savers may have to strive harder to make their money work with the economic backdrop continuing to hamper the thrifty for some time to come.

Source: (c)2013 Daily Mail (London) Distributed by MCT Information Services

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