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AAA Q&A: why the UK's rating downgrade matters

Moody’s decision to strip the UK’s of its prized AAA credit rating late last Friday has huge political, economic and investment significance.


by Gavin Lumsden, Chris Marshall on Feb 25, 2013 at 11:30

Why is Moody’s concerned?

Although a AA1 rating is still high, Moody’s says the downgrade was needed to reflect continued weakness in the UK economy and the country’s rising debt burden. It is concerned by the chancellor’s decision to delay his debt reduction target until beyond the next election.

London, 22 February 2013 -- Moody's Investors Service has today downgraded the domestic- and foreign-currency government bond ratings of the United Kingdom by one notch to Aa1 from Aaa. The outlook on the ratings is now stable.

The key interrelated drivers of today's action are:

1. The continuing weakness in the UK's medium-term growth outlook, with a period of sluggish growth which Moody's now expects will extend into the second half of the decade;

2. The challenges that subdued medium-term growth prospects pose to the government's fiscal consolidation programme, which will now extend well into the next parliament;

3. And, as a consequence of the UK's high and rising debt burden, a deterioration in the shock-absorption capacity of the government's balance sheet, which is unlikely to reverse before 2016.

At the same time, Moody's explains that the UK's creditworthiness remains extremely high, rated at Aa1, because of the country's significant credit strengths. These include (i) a highly competitive, well-diversified economy; (ii) a strong track record of fiscal consolidation and a robust institutional structure; and (iii) a favourable debt structure, with supportive domestic demand for government debt, the longest average maturity structure (15 years) among all highly rated sovereigns globally and the resulting reduced interest rate risk on UK debt.

The stable outlook on the UK's Aa1 sovereign rating reflects Moody's expectation that a combination of political will and medium-term fundamental underlying economic strengths will, in time, allow the government to implement its fiscal consolidation plan and reverse the UK's debt trajectory. Moreover, although the UK's economy has considerable risk exposure through trade and financial linkages to a potential escalation in the euro area sovereign debt crisis, its contagion risk is mitigated by the flexibility afforded by the UK's independent monetary policy framework and sterling's global reserve currency status.

In a related rating action, Moody's has today also downgraded the ratings of the Bank of England to Aa1 from Aaa. The issuer's P-1 rating is unaffected by this rating action. The rating outlook for this entity is now also stable.


The main driver underpinning Moody's decision to downgrade the UK's government bond rating to Aa1 is the increasing clarity that, despite considerable structural economic strengths, the UK's economic growth will remain sluggish over the next few years due to the anticipated slow growth of the global economy and the drag on the UK economy from the ongoing domestic public- and private-sector deleveraging process. Moody's says that the country's current economic recovery has already proven to be significantly slower -- and believes that it will likely remain so -- compared with the recovery observed after previous recessions, such as those of the 1970s, early 1980s and early 1990s. Moreover, while the government's recent Funding for Lending Scheme has the potential to support a surge in growth, Moody's believes the risks to the growth outlook remain skewed to the downside.

The sluggish growth environment in turn poses an increasing challenge to the government's fiscal consolidation efforts, which represents the second driver informing Moody's one-notch downgrade of the UK's sovereign rating. When Moody's changed the outlook on the UK's rating to negative in February 2012, the rating agency cited concerns over the increased uncertainty regarding the pace of fiscal consolidation due to materially weaker growth prospects, which contributed to higher than previously expected projections for the deficit, and consequently also an expected rise in the debt burden. Moody's now expects that the UK's gross general government debt level will peak at just over 96% of GDP in 2016. The rating agency says that it would have expected it to peak at a higher level if the government had not reduced its debt stock by transferring funds from the Asset Purchase Facility -- which will equal to roughly 3.7% of GDP in total -- as announced in November 2012.

More specifically, projected tax revenue increases have been difficult to achieve in the UK due to the challenging economic environment. As a result, the weaker economic outturn has substantially slowed the anticipated pace of deficit and debt-to-GDP reduction, and is likely to continue to do so over the medium term. After it was elected in 2010, the government outlined a fiscal consolidation programme that would run through this parliament's five-year term and place the net public-sector debt-to-GDP ratio on a declining trajectory by the 2015-16 financial year. (Although it was not one of the government's targets, Moody's had expected the UK's gross general government debt -- a key debt metric in the rating agency's analysis -- to start declining in the 2014-15 financial year.) Now, however, the government has announced that fiscal consolidation will extend into the next parliament, which necessarily makes their implementation less certain.

Taken together, the slower-than-expected recovery, the higher debt load and the policy uncertainties combine to form the third driver of today's rating action -- namely, the erosion of the shock-absorption capacity of the UK's balance sheet. Moody's believes that the mounting debt levels in a low-growth environment have impaired the sovereign's ability to contain and quickly reverse the impact of adverse economic or financial shocks. For example, given the pace of deficit and debt reduction that Moody's has observed since 2010, there is a risk that the UK government may not be able to reverse the debt trajectory before the next economic shock or cyclical downturn in the economy.

In summary, although the UK's debt-servicing capacity remains very strong and very capable of withstanding further adverse economic and financial shocks, it does not at present possess the extraordinary resilience common to other Aaa-rated issuers.


The stable outlook on the UK's Aa1 sovereign rating partly reflects the strengths that underpin the Aa1 rating itself -- the underlying economic strength and fiscal policy commitment which Moody's expects will ultimately allow the UK government to reverse the debt trajectory. The stable outlook is also an indication of the fact that Moody's does not expect further additional material deterioration in the UK's economic prospects or additional material difficulties in implementing fiscal consolidation. It also reflects the greater capacity of the UK government compared with its euro area peers to absorb shocks resulting from any further escalation in the euro area sovereign debt crisis, given (1) the absence of the contingent liabilities from mutual support mechanisms that euro area members face; (2) the UK's more limited trade dependence on the euro area; and (3) the policy flexibility that the UK derives from having its own national currency, which is a global reserve currency. Lastly, the UK also benefits from a considerably longer-than-average debt-maturity schedule, making the country's debt-servicing costs less vulnerable to swings in interest rates.


As reflected by the stable rating outlook, Moody's does not anticipate any movement in the rating over the next 12-18 months. However, downward pressure on the rating could arise if government policies were unable to stabilise and begin to ease the UK's debt burden during the multi-year fiscal consolidation programme. Moody's could also downgrade the UK's government debt rating further in the event of an additional material deterioration in the country's economic prospects or reduced political commitment to fiscal consolidation.

Conversely, Moody's would consider changing the outlook on the UK's rating to positive, and ultimately upgrading the rating back to Aaa, in the event of much more rapid economic growth and debt-to-GDP reduction than Moody's is currently anticipating.


The UK's foreign- and local-currency bond and deposit ceilings remain unchanged at Aaa. The short-term foreign-currency bond and deposit ceilings remain Prime-1.


Moody's will assess the implications of this action for the debt obligations of other issuers which benefit from a guarantee from the UK sovereign, and will announce its conclusions shortly in accordance with EU regulatory requirements. Moody's does not consider that the one-notch downgrade of the UK sovereign has any implications for the standalone strength of UK financial institutions, or for the systemic support uplift factored into certain UK financial institutions' unguaranteed debt ratings.


Moody's previous action on the UK's sovereign rating and the Bank of England was implemented on 13 February 2012, when the rating agency changed the outlook on both Aaa ratings to negative from stable. For the UK sovereign, the actions prior to that were Moody's assignment of a Aaa rating to the UK's government bonds in March 1978 and the assignment of a stable outlook in March 1997. For the Bank of England, the action prior to the one from February 2012 was the assignment of a Aaa rating and stable outlook in March 2010.

The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2008. Please see the Credit Policy page on for a copy of this methodology.

Financially the rating is important because it says that that the government bonds – or gilts – that the UK issues to borrow money from investors are not quite as secure as they were.

Gilts have enjoyed a ‘safe haven’ status since the financial crisis but if the Moody’s downgrade causes investors to sell gilts, it would mean interest rates would rise in the UK. This would hit mortgage and business borrowers and undermine any recovery in the economy. It would also push up the amount the UK pays in interest on its debts.

Moody’s also downgraded the Bank of England from AAA to AA1 as the Bank has bought over a third of all gilts since 2009. Under its controversial ‘quantitative easing’ programme the Bank has created £375 billion of new money with which to stimulate the economy. Buying gilts is the way it gets the money into circulation.

Some say the only achievement of QE has been to weaken the pound.

Next: Why is the pound falling?

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14 comments so far. Why not have your say?

John C

Feb 25, 2013 at 13:48

As someone once said, who rates Moody's and who pays them?

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Clovis Bassington

Feb 25, 2013 at 14:26

Not good, not good at all, however the impact may not be that great as it was expected and perhaps overdue. After all, the deficit reduction programme has been half-hearted (and this will not make it easier). Less forgivable failures are the lack of supply side reforms, meaningful cuts in plutocracy or abolition of capital taxes that raise no money.

Frankly, Osborne has underperformed, but the bigger failure is Cable’s. If his role has to remain a Lib Dem fief, then Laws or Alexander should take over. Otherwise give the Lib Dems something else, Libraries or the Post Office or something and get a Tory who understands business in there.

For a coalition effort, it’s not been too bad and a certainly lot better than if Balls and Miliband had been in control. If they had been, we would be staring at B!

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Feb 25, 2013 at 14:36

Apparently, the UK lost its AAA credit rating in, let's get the facts right, Gavin and Chris ;)

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Tom Mackay

Feb 25, 2013 at 14:38

If you are running a company and it starts to lose money you don't just stop spending but rather you manage your resources and change your priorities etc. Cameron and Osborne are boys in charge of the ship. Milliband I would put in the same camp and while we may have issues with Balls he does seem to have a better grasp of the need for management.

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wayne roberts

Feb 25, 2013 at 15:36

Even if the UK got a C Osborne would still stick to his plan, not quite enough people suffering for him yet, by the way some rooms in council houses have 4ft of empty space above peoples heads which works out at about 25% of unused space in council houses is being paid for by the government but not being used so there is a possibility of saving even more money from the poor by taking 25% off their housing benefits for that unused space. This is how the government that is running the 5th largest economy in the world plans on making it prosperous again, I'd give them a D.

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Feb 25, 2013 at 15:39

I am The Micky Mouse rating agency. I have downgraded Moody's to CC1 and all the rest of them will get same treatment if they just do a copy cat thing.

Actually, Who cares? Markets love rumour and silly stories in order to fiddle and make even more money. Which leads me to inquire, who makes trillions out of all this nonsense? Is it those naughty hedge funds and greedy bankers and all the rest of the rotten lot twisting, bending the facts and laws to shovel more money in to their bulging pockets?

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Mike R

Feb 25, 2013 at 16:48

As has been said- Moody's makes money and has clients who pay them. The news Moody's impart is not "News" but it is part of a trigger for those betting in the Financial markets. The FX perhaps now being one of the front runners in this style of betting and speculation. Europe has of late experienced this with Bond Markets.

But a weak currency which is not controlled and unstable, may not assist exports. But may influence and be counterproductive to other aspects of the UK economy. The affects of the latest drop in the Pound against the Dollar/Euro have yet to filter through in Higher Import and Fuel prices, amongst other things.

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Anonymous 1 needed this 'off the record'

Feb 25, 2013 at 17:05

Good article, thank you...... Moody's has got it right, UK well..... a sinking ship..... not much can be done except lower the standard of living of the average person until we can again compete in the world markets, and the Government is doing that......

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Feb 25, 2013 at 18:11

With the drop in Sterling our GDP as measured by the rest of the World has fallen by the same amount. Given that we had years of false GDP increases driven by ever increasing credit, then as this credit is withdrawn one would expect a big drop in GDP. And this drop should be more than the extra created by the false boom, as people start to repay their debts.

So, in Sterling terms GDP has held up surprisingly well. Of course the media, Milliband & Balls do not understand this and call the slight drop in GDP a "recession" when it is just a part correction.

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Clive B

Feb 25, 2013 at 18:23

It's about time we stopped mucking about with so-called "austerity" (isn't our national debt still increasing ?) and started living within our means.

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Rathin Gupta

Feb 25, 2013 at 18:28

Here it goes;

Political impact : definitely some; general election is still some 2 years away; this may not be significant unless the economy fails to pick up some what.

Economic Impact : probably none, difficult to quantify.

Investment impact : very doubtful as the Gilt buyers don't take much notice of the Rating Agencies.They have their own methods to establish which countries are a safe bet.

New Chancellor : we urgently need one who can instill confidence & inspire the nation.

This article : in -coherent , rambling & deserves 5/10

Rating Agencies : abandon them; where were they during mortgage miss-selling & recent financial crisis etc.

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Feb 25, 2013 at 21:44

Rather like media coverage of most events. Much ado over nothing. There never was a quick fix to the UK's problems. Why do "we" consider ourselves to be superior beings. Consumer debt after years of lax lending for property is the millstone around the UK's neck.

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Mike R

Feb 25, 2013 at 21:56

well never mind - the scene has changed. In the space of a few hours. The pound is up and the Euro is down. Markets are back to worrying about Europe.

Is Bunga Bunga Berlusconi back ???

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Feb 25, 2013 at 22:31

QE is really just a way for the government to fund its deficit. As it allows them to borrow money at a very low interest rate. QE is also like an additional tax on savers, it devalues their money through monetary inflation. The Bank of England have denied this stating they were going to pay back the money once the economy had recovered, in their heart they must have known they were never going to pay it back.

Printing money has never solved an nations problems but it is something politicians are attracted to as it allows them to keep spending money they don't have. We are surely now just witnessing the decline of our nation.

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