Q&A: UK credit rating downgrade

Moody's logo Moody's credit rating agency rates countries on their ability to pay back loans

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The UK has lost its triple-A credit rating for the first time since the 1970s. Moody's, one of the three biggest credit rating agencies in the world, has downgraded its assessment of the outlook for the UK economy.

Its more negative view of how long it will take to recover from the downturn will increase pressure on Chancellor George Osborne just weeks before the Budget. But what does this downgrade mean - and does it matter?

What is a credit rating?

Credit ratings are issued by credit rating agencies, private companies who sell their financial analysis to investors.

They mark potential investments using a scorecard system and each agency uses different ones.

The main one used by Moody's goes from Aaa to C. The UK was moved down one step on the scale from Aaa to Aa1.

In the case of countries, agencies are assessing their creditworthiness - their ability to pay back money lent to them.

The less likely a country is to be able to pay back its debts, the lower the rating.

Why has the UK lost its AAA rating?

Moody's now expects that economic growth will be "sluggish" into the second half of the decade.

This means it will take longer for the government to reduce its budget deficit - the amount it has to borrow every year because it is spending more than it receives in tax revenue.

The lack of growth makes cutting the deficit more difficult because when an economy is not growing, less tax is coming in from companies and individuals, while the government has to spend more on welfare payments, such as unemployment benefit.

And as the UK's debt problem will take longer to get under control, there will be a deterioration of the country's "shock-absorption capacity".

In other words, it will make it harder for us to cope with any external problems, such as a worsening of the crisis in the eurozone, our main trading partner.

There were some positive remarks, too, however.

Moody's said the UK's creditworthiness was still "extremely high". It pointed to strengths such as a highly competitive economy and a strong track record in being able to get debt under control.

Does the downgrade matter?

It looks as though it will continue the decline in the value of sterling, as investors move their money into currencies used by countries with better growth prospects.

A weaker pound would help exporters, but it also makes imports more expensive.

We have already seen the price of petrol go up over the past month and further increases like these could put more pressure on household incomes and company profits, and therefore on economic growth as a whole.

In theory, a lower credit rating could also make it more expensive for the UK to borrow money.

It works in a similar way to when you are borrowing from a High Street bank. If you are in a well-paid job and are living within your means, you will have to pay a lower interest rate on a loan than someone who the bank thinks is overstretched and may have difficulty keeping up with the repayments.

And this matters, as the UK currently needs to borrow more than £100bn a year from investors, both at home and around the world.

However, after the US lost its AAA rating in 2011, the amount it had to pay to borrow actually went down, as investors still viewed the country as one of the safest bets in the world.

What's more, some have said that the agencies are just stating what was already clear - that the UK's economic problems, in line with many other countries, will take longer to resolve than expected.

It is also important to point out that the credit rating agencies themselves lost credibility after the financial crisis, when they were found to have given top ratings to investments that turned out to be worthless.

What does it mean for the government?

Politically, the downgrade could be much more significant.

Labour was quick to describe it as a "humiliating blow" for the government.

This is because, throughout his time as Chancellor, George Osborne has used the threat of a downgrade as a justification for the scale and speed of deficit-cutting measures.

When others said he should pull back on spending cuts and tax rises, because of the possible negative impact on the country and the economy, the chancellor cited the need to maintain credibility in the eyes of the markets. They needed to be convinced that the government was serious about getting its finances under control, he said.

It was seen as an achievement that the UK was one of only three major industrialised nations to maintain a triple-A rating from all agencies - Canada and Germany being the others.

So will the government now change its economic policy?

Not according to George Osborne.

"Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it," he said in response to Moody's announcement.

"We will go on delivering the plan that has cut the deficit by a quarter."

Others, however, will see the downgrade - and Moody's suggestion that recovery may not come until after 2015 - as a reason to reduce borrowing more slowly and to focus on measures to boost jobs and growth.

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