Fitch Downgrades UK Credit Rating

Four weeks after the UK announced its budget for 2013-14, Fitch removes the UK credit rating from its AAA perch, downgrading it to AA+ and issuing a stable outlook. Moody’s was the first major agency to downgrade the UK from Aaa rating in February. As rating downgrades become the norm, markets are placing more weight on the accompanying outlook to glean an idea on the likelihood of further action.

Fitch also downgraded the UK’s GDP growth outlook for 2013 and 2014 to 0.8% and 1.8% respectively, from September’s projections of 1.5% and 2.0%. Interestingly, the 0.6% growth forecast for 2013 is higher than the Treasury’s 0.6% made at last month’s Budget.

Fitch acted on last year’s downgrade warning based on the UK’s failure to stabilise its debt/GDP ratio below 100% and to “place it on a firm downward path towards 90pc of GDP”.  That did not happen.

Fitch also recognized the UK’s advantage to set currency policy independently as well as its reserve currency status, but noted that these attributes were no longer sufficient to withstand the deteriorating dynamics of rising debt and slowing growth. FX traders are increasingly banking on this attribute as a ways to bet on prolonged declines in the pound sterling.

Timing also matters. The budget deficit has been reduced to 7.4% of GDP, but the fact that it’s not expected to reach below 6% of GDP until 2015 is too little too late for Fitch.

Fitch vs. S&P & France vs. UK

For those who like to compare UK & France credit ratings, Standard & Poor’s is the only major credit agency with AAA rating for the UK, while Fitch is the only agency with a AAA rating for France. France’s deficit stands at a manageable 5.2% of GDP but surging size of total debt draws credit agencies’ scrutiny. Lacks power to depreciate its own currency.

Thus, although both countries’ debt stands around 89% of GDP, France’s debt deficit (total debt minus government receipts from exports and taxes) is under 5.0% of GDP versus nearly 8.0% of GDP for the UK. And if the UK economy dips back into recession for the 3rd time (as it has been warned by BoE’s Weale yesterday), then prospects of improved government revenues may be slim. Another key factor considered by credit rating agencies (but not as much by the public) is the maturity of the debt ie how much needs to be repaid this year and the next. By end of 2013, the UK must repay over £132 bln in principal and interest payments, half the amount owed by France.

Sterling was hit by the news primarily against USD and euro, but ended up higher against the yen. The real test will come next week, when the advanced Q1 GDP figures are due on Thursday. Consensus expects a q/q rise of 0.1% in Q1 from -0.3% in Q4, and a y/y rise of 0.4% from 0.2%.It is unlikely until then for GBPUSD to regain the $1.54 level.  Markets insist on selling the bounce until another initial print of $1.49.