Rating agency Standard &Poor’s put the UK on negative credit watch last week. Not even the government’s pledge to maintain is budget deficit target for the fiscal year 2012/13 in the Chancellor’s Autumn Budget statement was enough to placate S&P. In the next six months there is a high chance that the UK could lose its coveted triple A credit rating, which would be the first time it has lost triple A status since the 1970’s.
UK Gilt yields actually fell on the news and the pound continued its climb higher as risk sentiment picked up on Friday. As we have seen in the US and France, both countries who lost their triple A ratings in the last 18 months, the blow is more symbolic and has virtually no impact on the markets. Even if the UK does lose its triple A credit rating we don’t think it will dramatically alter borrowing costs or the strength of the pound, which are both impacted by external events more than domestic factors.
However, it is a timely reminder that the UK’s financial position remains perilous. This could be reinforced this week as the November borrowing data is expected to show another rise in government borrowing relative to 2011. The market expects that borrowing (ex. financial sector interventions) is expected to rise to GBP 16bn, which is GBP0.5bn larger than this time a year ago. The Chancellor has been lucky that the deficit has been stable this year, but it mostly down to one-off factors and the truth is that the underlying rate of borrowing remains too high.
Already the public sector austerity drive is expected to last by one extra year to 2016/17, and if borrowing remains at this level then we could see deeper cuts between now and then that weigh on the economy.
The UK’s public finances are not a key driver of sterling or UK based asset markets at the moment, but they could be. The Chancellor is well aware that debt becomes an issue once it becomes an issue; Italy is a case in point. Thus we expect to see more austerity-rhetoric in the medium-term.
There is a hefty data schedule before things quieten down in the UK for the Christmas break. The minutes of the December BOE meeting are expected to show that David Miles was alone in voting for more QE, this suggests that the BOE remains in wait-and-see mode, which is mildly GBP positive in the short term. Retail sales for November are expected to rise by 0.4%; however this won’t fully reverse the 0.7% decline in sales in October. Thus, we may see a more frugal consumer in the UK this holiday season, which may weigh on Q4 growth.
Stock markets have backed off recent highs, including the FTSE 100. However, if we get back below 5,900 towards 5,830 in the near-term, this may attract some buying interest as Chinese growth is picking up, which may boost risk sentiment in the medium-term. 6,000 remains the key resistance level. A satisfactory outcome of the fiscal cliff negotiations could be enough to give risk a leg higher in the medium-term, in our view. Thus, when trading the FTSE 100 watch what is going on in Capitol Hill.