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UK debt outlook cut from 'stable' to 'negative' by Fitch: What does it mean?

Fitch said:

UK government debt outlook downgraded from stable to negative by US ratings agency Fitch: what does it mean – and does it matter?

  • Fitch has become the latest agency to worry about the UK debt outlook
  • The rating agency warned of “a significant increase in budget deficits”
  • The move puts further pressure on the cost of debt as borrowing increases

Britain’s public debt outlook was downgraded from ‘stable’ to ‘negative’ by Fitch yesterday as the New York credit rating agency reacted to the Chancellor’s ‘unfunded fiscal package’.

Fitch cited the government’s “weakened political capital” to justify the change, warning that Kwasi Kwarteng’s unwelcome mini-budget could lead to “significant increases in budget deficits over the medium term”.

The agency also pointed to the lack of independent forecasts from the Office for Budget Responsibility and an apparent conflict with the Bank of England’s strategy to fight inflation.

Fitch said:

Fitch said: “The government’s weakened political capital could further undermine the credibility and support of the government’s fiscal strategy”

Fitch said: ‘Although the government has reversed the elimination of the maximum tax of 45p…the government’s weakened political capital could still undermine the credibility and support of the government’s fiscal strategy.’

Days earlier, Fitch’s rival Standard & Poor’s threatened to downgrade Britain’s debt after giving the country a “negative outlook” following the Kwarteng fiscal event.

The mini-budget at the end of September precipitated a fall in the value of the pound sterling against the US dollar and caused the yield on government bonds – the gilts – to skyrocket, the latter having required the intervention of the Bank of England after leading to a potential pension crisis. market.

While Fitch and S&P have maintained their credit ratings at AA- and AA, respectively, the change in outlook is another headache for the government as the move weighs on investors’ perception of the risk of UK debt and therefore about the compensation they require in exchange for the purchase. this.

Fitch, S&P and Moody’s are the three major rating agencies responsible for assessing the likelihood of a borrower repaying their debts.

This information is used to help those buying or selling existing debt, such as gilts.

If a country sees its rating downgraded, it means that the rating agency has a little less confidence in its ability to repay its existing debts, probably because it believes the country’s economic prospects have weakened.

A country with a downgraded rating may see its cost of borrowing increase – lenders will want a higher interest rate to match the increased risk.

Obligations and prices

Simply put, when a country borrows money, it issues bonds, which global investors buy in exchange for regular, reliable income from the issuing country.

These periodic interest payments are called coupons.

Bonds are issued at a price known as par – say £100 – with a fixed coupon paid over their term and the capital invested repaid at the end.

These bonds can then be traded on secondary markets and their price can go up or down above or below their face value.

The price of a bond has an inverse relationship with the yield paid.

When bonds are out of favor and trading below their face price, the buyer buys the coupon payments at a discount and thus their yield increases.

Conversely, if bonds are in high demand, they may trade above their nominal price and their yield will fall.

The UK saw its credit rating cut by Moody’s in 2017 – by three notches – from AAA to AA2, after Theresa May’s government backed out of former Chancellor George Osborne’s austerity campaign.

At the time, Moody’s also highlighted the economic risks that leaving the European Union posed to the world’s fifth largest economy.

Gilts sold off again on Thursday, taking two-year, five-year, 10-year and 30-year yields to 4, 4.3, 4.1 and 4.3%, respectively, at midday.

Gilt yields remain below their levels immediately after the mini-budget, but are well above what they have been for most of this year, having started 2022 at around 1%.

Susannah Streeter, senior investment and market analyst at Hargreaves Lansdown, said: “Prime Minister [Conservative Conference] Yesterday’s speech was nothing new to reassure markets and with political divisions widening within his party over how to pay for big promises of tax cuts, ratings agencies are far from to be impressed.

“Fitch has followed S&P to reduce the outlook for Britain’s AA investment rating from stable to negative.

“This matters because even without a downgrade, UK borrowing costs have risen sharply, and if the ‘stable’ rosette is torn away, overseas creditors are going to demand even more money to finance the government’s growing debt. ” Moody’s also warned that deep unfunded tax cuts could hurt the country’s debt affordability.

Streeter added that gilt yields are “going back up again” despite the BoE’s intervention and, if they continue to climb, the bank “may have to dive back into bond buying.”

Head of Investments at Interactive Investor Victoria Scholar said: ‘There are serious concerns about the government’s unfunded stimulus and what rising borrowing levels will mean for the UK inflation conundrum as well than its level of indebtedness over time.

“The UK is already facing historically high levels of debt in the aftermath of the pandemic when billions have been spent on costly emergency programs such as the furlough scheme, monitoring and follow-up and deployment of the vaccine.”

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