A nation feels humiliated. But enough about the English soccer team’s defeat by Iceland. The Brexit-related downgrades of the UK’s credit rating are a blow too, but more psychologically and politically than financially.
Standard & Poor’s cut the UK a hefty two notches to AA from AAA on June 27 with Fitch following with a one-notch move to AA. Both have a negative outlook. The rationale is far from surprising: a more uncertain outlook for the UK outside the European Union, with slower growth and higher borrowing needs contributing to a heavier debt burden.
That is a potential concern given the UK’s big current-account deficit makes it reliant on attracting foreign financing.
But the rating cuts themselves shouldn’t cause too many ripples. Downgrades were expected, and there are many fewer triple-A rated assets in the world after the financial crisis. Vitally, like Japan and the US, both of which have faced downgrades, the UK’s control of its own currency means questions of creditworthiness are about willingness to pay, not ability to pay. Unlike in the eurozone crisis, where investors fled from troubled countries and into nations like Germany, there is no large, liquid pool of sterling assets as a handy alternative.
UK gilt yields rose early on June 28, but that reflects a wider bounce in markets, with stocks rising and sterling off its lows. German and US yields rose too. In the post-referendum turmoil, gilts behaved very much as a haven: over June 24 and June 27 alone, the market returned 4.2% and bonds maturing in 25 years or more gained 7.9%, according to Barclays index data.
That also reflects expectations that the Bank of England will loosen monetary policy, with some suggesting that quantitative easing could be restarted.
Measures other than ratings will prove more consequential. Sterling’s plunge has hurt foreign investors. The pound is still a reserve currency, though of smaller stature than the dollar and the euro, accounting for 4.9% of international reserves, according to International Monetary Fund data. In the long run, official holdings of sterling could be seen as a barometer of its success or otherwise.
Politically, the downgrade is a knock to a UK seeking to redefine itself in the new world. The snap verdict is in. It will take years to discover the lasting impact of the UK’s decision.
Write to Richard Barley at email@example.com
This story was first published by The Wall Street Journal’s Heard on the Street column