The Bank of England, the central bank of the United Kingdom, is charged with maintaining a strong economy by providing monetary and financial stability, just as any other central bank.
In an effort to control inflation, the bank’s Monetary Policy Committee sets the interest rates it charges for lending to financial institutions. Inflation occurs when prices for goods and services rise and the purchasing power of consumers falls.
“A reduction in interest rates makes saving less attractive and borrowing more attractive, which stimulates spending. … The opposite occurs when interest rates are increased,” an entry on the Bank of England website states.
The Bank of England’s interest rate took a nose dive from a 21st century high of 5.75 percent on July 5, 2007, to 0.5 percent on March 5, 2009, where it remains today. This is a substantial drop in comparison to its high rate of 17 percent on Nov. 15, 1979.
Cause for Optimism
The U.K. economy is on a slow upward trend. “Yet there is cause for optimism. Today too, a recovery is in sight,” said Mervyn King, Governor of the Bank of England, in his Feb. 13 press conference opening remarks, published on the bank’s website.
The U.K. Consumer Price Index (CPI), which measures the cost of goods purchased by U.K. consumers, has remained flat at 2.7 percent since October 2012, rising from 2.2 percent in September 2012.
U.K.’s National Institute of Economic and Social Research (NIESR) states in a Feb. 5 announcement that the U.K. economy will grow from a zero growth rate in 2012 to 0.7 percent in 2013 and another 1.5 percent in 2014.
“Recovery depends upon a resumption of consumer spending, while balanced recovery also requires the resumption of corporate spending and a pick up in export growth,” the NIESR states.
Losing Cherished Aaa Credit Rating
Moody’s Investors Service, the globally recognized rating agency, didn’t feel the muted optimism of the Governor of the Bank of England and downgraded the U.K. by a notch, from Aaa to Aa1, resulting in the Bank of England also being downgraded from Aaa to Aa1.
“Moody’s Investors Service has today downgraded the domestic- and foreign-currency government bond ratings of the United Kingdom by one notch to Aa1 from Aaa. The outlook on the ratings is now stable,” according to a Feb. 22 announcement on the Moody’s Investors Service website.
The U.K. has joined France, Italy, Malta, Portugal, Slovakia, Slovenia, and Spain, countries that have been downgraded by either one or all of the following rating agencies: Moody’s, Standard & Poor’s, and Fitch.
Moody’s points to slow growth, which might continue for a number of years, and an unsustainable debt burden that will continue over the next two years.
On the positive side, Moody’s states, “The stable outlook on the U.K.’s Aa1 sovereign rating reflects Moody’s expectation that a combination of political will and medium-term fundamental underlying economic strengths will, in time, allow the government to implement its fiscal consolidation plan and reverse the UK’s debt trajectory.”
Not a Big Deal
“Moody’s said a year ago that it was putting the U.K. on watch. … America has already been downgraded, as have all the other G7 countries except Germany (which should be) and good ol’ conservative Canada. In the great scheme of things, the UK doesn’t look in too bad shape,” according to a Feb. 25 article on the Adam Smith Institute website.
A Feb. 25 article on The Spectator blog says it even more effectively: “Moody’s downgrade of U.K. government bonds on Friday night has—so far—had more effect on the headlines than the markets.”
The downgrade could result in higher interest costs for a sovereign borrower when borrowing in the long term, such as 15 to 20 years. This will increase the government’s debt burden, but it won’t cause difficulties for U.K. consumers, who mostly borrow in the short term, the Adam Smith Institute article states. Moody’s maintained the U.K.’s short-term credit rating of P-1.
Some economists and market experts said that the downgrade is a bad mark concerning the U.K. government’s economic competence, as well as for those who are pushing tax cuts for businesses.
“The U.K. needs not to spend more, but to get its debt under firmer control. Indeed, it [Moody’s position] is telling the Chancellor to stick to his plan of getting the books back into balance, and indeed to speed up the process if he can,” the Adam Smith Institute article advises.
Moody’s downgrade affected the U.K. currency modestly. The British Pound Sterling (GBP) dipped from $1.52486 on Feb. 21 to $1.51309 on Feb. 22, remaining there through Feb. 24. Starting on Feb. 25, the GBP fluctuated, reaching $1.51035 on March 4, according to a historical chart on the Fx Currency Exchange website.
A Feb. 23 article on the Zero Hedge website states that governments are not like corporations, where a rating agency has access to insider information. Concerning the rating of sovereigns, especially those of developed nations, rating agencies are not privy to any more information than the average investor. The article went on to say that Moody’s valuation didn’t bring anything new to the table, absolutely nothing investors could use for changing their assessments.
“That there is extremely little value-added or new information contained in a rating agency is evident in the lack of market response to downgrades of Japan, the US, Austria, and France, for example. There is little reason to expect the UK to be an exception to the rule,” according to the Zero Hedge article.
British EU Skepticism Affects Moody’s Rating
“Britons are consistently more Eurosceptic than the people of any other major EU country. … The vast majority of them [British nationalists] think the EU has been a failure,” according to an Oct. 5, 2012, article on the European Council on Foreign Relations website.
The Britons think being British is important, while the government of Britain believes that remaining in the EU is of importance if the interests of Britain are to be taken into account.
In a Jan. 23 speech at Bloomberg’s EU headquarters in London, Britain’s Prime Minister David Cameron stated that the EU is at a crossroads, which requires “fundamental change,” including the need to address global competitiveness problems and the need for assurances that the single market structure will not be compromised.
Cameron addressed the discontent with the EU displayed by the Britons, given its regulations and directives were set up without British input. He suggested that once a new EU credo is established, he will give Britons the opportunity to voice their opinion through a referendum. At that time, they will vote on whether to remain a member of the EU or go on their own.
Britain’s decision to distance itself from the EU by having its own currency was seen as a positive by Moody’s. Moody’s states that its rating “reflects the greater capacity of the U.K. government compared with its euro area peers to absorb shocks resulting from any further escalation in the euro area sovereign debt crisis, given … the U.K.’s more limited trade dependence on the euro area; and … [being a] global reserve currency.”