Will the UK lose its credit rating before the US?
Like F1 “fans” waiting for a car crash, international investors are watching to see who loses its AAA credit rating first – the United Kingdom or United States. Both countries have huge budget deficits and high debt: so which will be stripped of its top rating, or will both be downgraded?
While sterling is falling on the prospect of losing the prized credit rating, the dollar remains strong. From $2, the pound has fallen below $1.50. So America wins that race.
The annual spending deficits of the two countries are very similar, with the UK spending 12.6 per cent more than its gross domestic product while the Americans overspend by 12.5 per cent. That’s too close to worry who wins and who is worse, but the ratio of debt to GDP shows a clear victor.
While Britain’s borrowing, at 69 per cent of GDP, is massive compared with its historic level of below 40 per cent, it is still lower than most other countries’. The UK is not only still more prudent than the known problem countries such as Ireland and Portugal (both 77 per cent) or Italy and Greece (both above 115 per cent), Britain’s borrowing is conservative compared with the solid and stable economies. Germany and France, like Canada, have debt of about 78 per cent of GDP.
And the US, at 85 per cent, is far worse than other major counties. (Japan’s debt is a whopping 219 per cent of its national output but that is either a warning to the West of why debt has to be brought down or proof that Tokyo exists in a different economic world.) However, the US has traditionally had a high ratio of borrowing: it finances its traditional overspending of the budget.
The consequences of losing an AAA credit rating are substantial, as any finance director lucky enough to have had one and unlucky enough to lose one knows. It would mean paying more for debt, and as losing countries have more debt than they should, that is extra interest on a big borrowing total.
Yet the UK is already paying more for its debt, possibility anticipating the loss of the credit rating. Treasury borrowing in Britain costs about 100 basis points – a full one percentage point – more than a similar loan by the German government. And because the UK has so much to borrow over the next year it would not be surprising to see the cost of medium term gilts rise further, from 4 to 4.5 per cent, irrespective of what the Bank of England does with interest rates.
One consequence of losing the AAA rating could be for Labour to lose the election – and that is one reason the rating agencies will not downgrade Britain before the country votes. As America has no elections until the autumn – and they cannot change the White House anyway – that is a distinct advantage to Britain is the transatlantic battle to hold onto its rating.
However, the truth is that neither country will be downgraded. The chance of either country defaulting on debt is less than negligible. Both countries need to take drastic and painful action to remedy their deficits and debt ratios, but they will. And while we are paying a price for our borrowing that reflects the loss of AAA status, cutting the rating is not necessary. It may spoil a lot of speculators’ fun, but the race is off.
