Pound struggles after UK debt downgrade

LONDON—The British pound fell sharply against other currencies before stabilising somewhat yesterday as investors reacted to the downgrade of the UK’s cherished triple-A credit rating.

During early trading, the British currency dropped to $1.5069 against the dollar—its lowest level since July 2010—before recovering to $1.5144. Against the euro, it hovered around 18-month lows, with one euro worth 0.8745 pound. Late Friday, after European markets had closed, Moody’s Investor Service downgraded the UK’s credit rating by one notch from the top AAA to AA1. It said sluggish economic growth would hinder the government's ability to control rising debt levels and deal with any new financial shocks.

Because it was the first such downgrade for Britain, which unlike the US or France had managed to hold onto its top rating during the global financial crisis, the knee-jerk market reaction was negative. But experts said the rating cut was somewhat expected.

“It is hardly a bolt from the blue,” said Jonathan Loynes, the chief European economics at Capital Economics. “Moody’s had the UK on negative watch since February 2012.” Two other ratings agencies—Fitch and Standard & Poor’s—have had Britain on so-called negative outlook, signaling they could lower the nation’s credit rating.

Government finances have struggled to recover as the economy has flat-lined in recent years. Public sector borrowing in December, for example, was higher than expected as government spending rose faster than income. The economy is close to falling into recession for a third time since the global financial crisis erupted.

Treasury chief George Osborne has said the downgrade only doubles his commitment to the government’s policy of cutting spending in an effort to reduce deficits. Prime Minister David Cameron also signaled he planned to stay the course.

“It’s a very clear message that Britain as a country cannot let up with dealing with its debt,” said Cameron’s spokesman, Jean-Christophe Gray. “It’s a reminder—if anybody needed one—that the UK has a very significant debt and deficit problem.”

A downgrade theoretically means there is a greater risk that Britain may default on its debt. That could increase the cost for Britain to sell bonds and finance its debt, worsening its budget problems. But there are times it doesn’t turn out that way.

When S&P downgraded the United States, it expressed concern that the America’s political system would fail to deliver on plans to reduce the federal government's debt. But despite the warnings, investors still bought US bonds, because economic turmoil in Europe and elsewhere made America’s debt appear safer.

British government bonds were in fact stable yesterday, with the 10-year interest rate edging up only 0.016 of a percentage point to 2.13 per cent. (AP)