The pound suffered a sharp decline this morning following media reports that the UK could lose its AAA credit rating if the government failed to meet its economic and fiscal targets. Moody’s had made similar indications in March, but the market responded nonetheless. However, sterling has recovered to finish slightly higher than where it started the day against the euro, though it has lost ground to US dollar.
The warning from Moody’s tells us little that we don’t already know. If the UK economy remains teetering on the edge of a double dip recession and if the government cannot reduce its enormous deficit, then it stands to reason that we should lose our AAA rating.
The pound is a very unappealing asset at present but today’s news is barely news, it merely states the obvious. However, data has been reasonably scarce this week and investors were prompted to act.
Moody’s has also been in the news on a potentially much more crucial matter. On the Greek debt issue, Moody’s has made its feeling known on the ECB’s endorsement of a rollover of Greek bonds. Trichet has given his support to the measure of requiring Greek bondholders to reinvest their funds in Greece upon the maturity of existing debt. A Moody’s head has classified such an event as a default, because it is a significant change to the terms of the initial agreement, and the rollover would almost certainly not be voluntary.
What’s more, as an FT Alphaville blog notes, if the ECB was seen to allow an effective default, this would trigger the downgrading of other peripheral nations’ debt, and so the contagion risk is highlighted again. So from this perspective, the ECB can dress it up as ‘soft restructuring’ all it likes, but the ratings agencies and market may see it as another thing altogether. So while most are confident a resolution will come soon, this does not necessarily rid the eurozone of the threat of debt contagion.
Richard Driver
Analyst – Caxton FX
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