The UK faces the very real prospect of further downgrades to its prized credit rating in the wake of its decision to leave the EU, according to senior fixed-income investors at Schroders and BlueBay Asset Management.
Moody’s, which stripped the UK of its triple-A rating in 2013, had already cut the country’s credit outlook to negative in the wake of the referendum result.
Economists had overwhelmingly warned that a vote to leave the EU would deliver short-term pain to the UK economy and the days since have been brutal for both UK-listed shares and the pound, which hit a 31-year low against the dollar on June 27.
Both S&P and Fitch cited concerns over constitutional and economic integrity as reasons for the downgrades, and fixed-income managers say it could yet get worse.
Gareth Isaac, a senior fixed income manager at UK-listed Schroders, said: “It is quite a conservative move. It could be downgraded further, depending on what the outcome is of the European talks and trajectory for the UK economy.”
Formal negotiations over the terms of the UK’s split from the bloc will begin when the new UK Prime Minister evokes Article 50. These negotiations will take at least two years, spelling prolonged uncertainty for financial firms waiting to see what kind of access they will have to the EU’s single market in the post-Brexit world.
Issac’s comments were echoed by David Riley, the head of credit strategy at alternatives firm BlueBay Asset Management, who said: “The expectation is that the credit ratings of the UK are more likely to come down in the future. Certainly, it seems very unlikely that they will go up for a very long time.”
Both Riley and Isaac – who also believes sterling has further to fall, potentially to as low as $ 1.20 – said the gilt markets could become more important to the UK as the economy is expected to slow in the wake of the referendum result.
Isaac said “the UK does run a rather substantial deficit and relies on external financing to meet the needs of the budget”.
With “very low growth or even a recession” on the cards, Isaac said gilt issuance would have to make up the difference.
But in the corridors of the City’s investment banks, debt capital markets bankers did not think the downgrades would affect the UK’s ability to raise money in the bond markets – though the head of supranational, sovereigns and agencies at one large firm said the moves, while expected, had been “at the more aggressive end” of the scale.
A European debt markets capitals head at another bank said: “Overall it’s not going to fundamentally affect the UK’s ability to raise its debt. It might have an impact on the price at which it raises the debt but it’s still rated double-A, which on a relative basis is pretty good by any international standard – and of course it has a very large captive domestic investor base.”
Simon Down, a senior investment manager at Nikko Asset Management, also said that before the global financial crisis, losing a coveted triple-A rating was a much bigger deal, and that now hardly any other country had one. “That has dampened the impact,” he said.