Market Analysis

Fitch’s ‘Fiscal Space’

Fitch seemingly Xeroxed Moody’s arbitrary rationale in downgrading the UK’s credit rating Friday.

Credit-ratings agency Fitch followed through Friday, downgrading the UK’s credit rating from AAA to AA+. The move is the UK’s second downgrade in as many months—Moody’s similarly cut the previously top-ranked Brits on February 22.

It’s another political black eye for Prime Minister David Cameron and Chancellor of the Exchequer George Osborne, who installed a deficit-reduction program primarily consisting of tax hikes beginning in 2010 on a platform promising to maintain the UK’s AAA. Some in the government are trying to put topspin on the move, pointing to Fitch’s statement that its stable outlook was in part underpinned by the government’s efforts to rein in deficits. With two of three raters downgrading, though, in our view it’s safe to call that campaign promise a dud. However, if there’s one campaign pledge that carries the least real economic impact, it’s probably this one. The negative economic impact of a AA+ UK is likely to be nearly nil.

We’re not accusing Fitch of copying Moody’s homework, but the actions and arbitrary rationales are nearly identical. Each rating is now one notch below top—Fitch-speak for Moody’s Aa1 is AA+. The rating outlook for each is “stable.” Both raters partly hinge their downgrades on the projection the UK’s weak economic conditions will continue into 2015/2016. But perhaps most curiously, each cite another bizarre factor: Per Fitch, “the fiscal space to absorb further adverse economic and financial shocks is no longer consistent with a ‘AAA’ rating.” Part of Moody’s rationale was the vague assertion there had been “a deterioration in the “shock-absorption capacity of the government’s balance sheet, which is unlikely to reverse before 2016.” (Emphasis ours.)

We’re interpreting “fiscal space” and “shock-absorption capacity” used in this context to mean the ability to launch a bailout or stimulus plan using borrowed money without any blowback on Britain’s capacity to service its debt. But if that interpretation is accurate, then we wonder exactly how Moody’s and Fitch reached their conclusions.

British 10-year bond rates finished Friday at 1.66%—a one basis point difference from a day earlier. Since Moody’s downgrade, rates have fallen about 50 basis points, a rather typical reaction to highly rated nations being downgraded (and the exact opposite of what most would fear). Bond markets tend to signify difficulty borrowing through higher rates, like when Greek rates shot skyward in 2010 and 2011, not lower like the UK’s. Maybe Moody’s and Fitch believe rates will rise from here, endangering Britain’s ability to borrow. But both raters acknowledge the weighted-average maturity on UK debt, at more than 14.5 years, is the longest of any developed, highly rated country. This implies the UK is less subject to changing interest rates than nearly any of its peers and has actually grown less sensitive to changing rates in recent years. The average maturity has grown from just under 11 years in March 2004.

How, exactly, cheaper borrowing for longer equates to running out of fiscal space is a bit beyond us. Perhaps they’re presuming the space is the gap between current deficit levels and Cameron/Osborne’s deficit-reduction targets, but those targets are merely political rhetoric. If the UK wanted to, it could follow France, the Netherlands, Portugal, Spain and others, all of which have revised deficit targets when they felt it necessary. Maybe Fitch feels the political capital is lacking, but calling that “fiscal space” would be very odd indeed.

That two raters now agree the UK doesn’t get their highest grade actually says less about the UK and more about ratings agencies’ lemming-like tendencies.

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