The downgrading of the UK government’s credit rating by Moody’s on the weekend sends a strong message to Australian politicians and fiscally hairy-chested media commentators as we head toward an election: austerity not merely doesn’t work, it won’t even save a country from the loss of its AAA credit rating.
Moody’s decision was a massive humiliation for Chancellor George Osborne. He virtually staked his chancellorship on a commitment that spending cuts were needed to preserve the UK’s triple-A rating, which he claimed in 2009 had been endangered by the Brown Labour government.
Well, it wasn’t Brown or his chancellor, Alistair Darling, who lost the UK’s triple-A rating, but Osborne. The news came just days out from a high-profile by-election in Eastleigh where a Labor victory could dramatically increase pressure on a shaky Coalition government.
Osborne can blame his own spending cuts. Rather than bolstering the credentials of an economy, austerity so weakens the level of demand and employment that the central budget is placed under rising pressure as tax revenues collapse or slow, and debt grows, rather than falling. The UK government has already acknowledged it will miss its spending reduction and debt targets.
The UK downgrading took everyone by surprise, coming well after markets had stopped trading for the week. Besides the US (which S&P downgraded in August 2011, while Moody’s and Fitch have maintained their AAA ratings), Britain joins the likes of France, Italy and Spain in suffering a credit rating cut in the last three years. The only countries left with a gold-plated rating from all three agencies are Australia, Canada, Denmark, Finland, Germany, Luxembourg, Norway, Netherlands, Singapore, Sweden and Switzerland.
The downgrade won’t have any immediate impact, but for Australia, it’s not good news because it means more interest in the Aussie dollar from big, conservative investors and institutions. Coming just as the dollar had fallen as a result of the emergence of changes in the Fed, Bank of England and Japan about further spending and the nature of it, the downgrading of the UK is likely to see the dollar remain buoyant rather than dip towards parity with the greenback.
Explaining the main reason for the downgrade, Moody’s said “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 de-leveraging process.” Moody’s basically agreed with the Bank of England’s outlook issued 10 days ago in its first official forecasts for 2013 and 2014. But unlike Bank of England governor, Mervyn King, who was confident he could see a recovery on the horizon for the UK, Moody’s could only see more of the same, a slow grinding two years with little if any growth and no fall in debt (although UK employment is stronger than the economy).
The downgrading of the UK finished what turned out to be an odd week for markets — boom, slump, surprise splits in the US Fed and the Bank of England on the future direction of quantitative easing, a change in Japan as well. The European Commission downgraded its growth forecasts for the continent for this year — basically there will be little growth at all — 0.5% for Germany and 0.1% for France at best.
For the week ahead we face the impact of the weekend’s odd Italian election which finishes tonight our time, sort of. Ahead lies horse trading over US federal spending and budget cuts: if no deal is done then big cuts come in automatically on Friday which would hit unemployment benefits, aviation and travel, defence, education and a host of other spending.
In Australia we get an update on private capital spending on Thursday (ahead of next week’s fourth quarter and 2012 GDP estimates) that will hopefully give us a clearer idea whether the resources investment boom has peaked, as the Reserve Bank and others seem to believe is very close.
But the stripping of the UK’s prized AAA rating should be heeded by politicians of all stripes, here, especially conservatives. Being hairy chested and obsessed with spending cuts no matter what the context has considerable downside, especially if it fails to even achieve the specific goal of reducing debt, as we have seen across Europe in every country where austerity has been tried. But the downgrade is also a slap in the face for the IMF and OECD, both of whom supported the Cameron government slash and burn tactics.
It’s not known if Moody’s move will be followed by other ratings groups. S&P and Fitch, which are both reviewing Britain’s rating, are expected to reveal their hand after Osborne’s budget on March 21. There are no good options for Osborne in preparing that document — only least-worst ones, on both the policy and political fronts.