Ratings agency Moody's last night slapped the UK with a downgrade to its ratings outlook, doing the same to France and Austria. Moody's also cut the ratings of Italy, Spain, Slovenia, Malta, Portugal and Slovakia. Not the sort of news Europe was hoping to wake up to.
So what's the significance?
We don’t see Moody’s decision to downgrade the UK ratings outlook as overly worrisome. It is just a warning but all the warning signs were already there; it stands to reason that negative growth and climbing public debt will result in a loss of the UK’s AAA rating. Still, after the recent strong PMI figures and last month’s improved public borrowing figures, Moody’s warning will come as a bit of kick in the teeth. Nonetheless, UK debt has climbed over £1trn and the UK ecoonmy looks hard-pushed to grow its way out of trouble any time soon. The Q1 outlook for UK growth is fairly grim but we should see it pick up later on in the year as things stand.
The deciding factor will be developments in the eurozone - regardless of the UK government’s attempts to boost growth whilst cutting debt, if the eurozone crisis escalates then they will prove largely irrelevant. The liquidity operations have reduced the risks of a major collapse in the eurozone but the situation remains incredibly uncertain.
Greece has passed the necessary austerity package and has thus gone a step closer to receiving a second bailout that will avert a messy Greek default in March. However, further budget cuts need to be agreed, a debt-swap still needs to be agreed, and the Troika need to be convinced that Greece can implement its austeirty promises. All this and we face the uncertainty of a Greek general election in April, which inevitably opens the door to policy u-turns. On balance, the UK may just be able to hang on to its AAA rating, provided the European financial system buys enough time to shore itself up.
Sterling has taken the warning from Moody’s in its stride – GBP/USD came off a little last night but this was mainly EUR/USD driven and it has found support at $1.57 regardless.
€1.19 (84p) should hold firm for GBP/EUR, whilst GBP/USD should be able to climb a little higher in the short-term before we see a reversal.
This morning’s UK inflation figure has also failed to leave much of a mark, the market is well aware that prices are set to ease sharply in the coming months.
Richard Driver
Analyst – Caxton FX
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