A Moody Valentines

The St Valentines’ gift from Moody’s was not what Europe would have wished for. A one-notch downgrade of Italy (to A3), Malta (A3), Portugal (Ba2), Slovakia (A2), Slovenia (A2) & a two-notch downgrade of Spain (to A3) put the recent rally on hold here this morning. However, stealing the limelight was the decision to place the triple-A rating of the UK on outlook negative (along with France and Austria). We have been warning about the risk of this for some months now so there are no great surprises here given the deterioration of the UK’s fiscal position over the past few years and the severe challenges that lay ahead.  However, it could have been worse; remember S&P placed the UK on outlook negative back in 2009 only to return it to stable some 18-months later. It is not the same as being placed on negative watch, which generally points to a rating decision within 3 months.

The trouble for the UK now however is where does the growth come from in order to reverse the deteriorating fiscal balance (or do higher taxes and further austerity measures have to be imposed)? According to the OECD the UK total debt to GDP was 85.5% in 2011 and is expected to exceed 90% by early 2013, well above the government’s sustainable investment rule of 40% and crucially above the 90% level at which agencies have been downgrading large triple-A sovereigns. Of course, this has been far higher during periods of stress (ie. our debt ratio was around 200% during the WW2) but in the current environment the UK could find it more difficult to borrow as markets have become more fickle with heavily indebted nations.

The situation is obviously not at a critical stage yet (and there could be a turnaround of fortune) but we do question whether this could take some of shine off the UK Gilt’s safe haven status that we have benefited from over recent years. As such we reiterate our opinion that there are more compelling sectors of the fixed income universe to find value.