Tuesday, June 28, 2016

Bond Rating: UK Relegated to 3rd Division

And so it begins.
As they warned, Standard & Poor's (S&P), Moody's Investor Services and Fitch Ratings -- the three most influential risk assessment agencies in the world -- have lowered their ratings of UK government bonds.
On referendum day, 23 June 2016, the UK was one of only 13 (out of 126 sovereign governments rated) with S&P's top AAA bond rating. 
However, S&P had already warned the UK that its top AAA rating was at risk. After then Prime Minister David Cameron’s EU referendum plan was confirmed by his re-election in May 2015, S&P assigned a “negative outlook” to the UK’s rating because the referendum “could negatively affect sustainable public finances, balanced economic growth, and the response to economic or political shocks”. 
S&P acted on this warning on 27 June 2016. S&P relegated the UK's bond rating two levels to third-tier AA -- the same rating as France. And, S&P maintained its “negative outlook” for the UK bond rating. This means that if the upcoming period of economic and political uncertainty does not go well, the UK is headed for a fourth tier AA- rating. 
Most Britons voting the leave the EU do not own bonds and may never have heard of S&P or care about what S&P or any other rating agency thinks of UK bonds. 
Perhaps an analogy with English soccer football might help. At the start of 2015 before the referendum became a certainty, S&P ranked the UK in the elite Premier League of only the safest government bonds rated AAA. The UK was like Manchester United near the top of the Premier League.
As the referendum loomed, S&P sent the UK down to near the bottom of the AAA league with its "negative outlook". UK bonds were then more like Crystal Palace near the bottom of the Premier League at the end of the 2015-16 season just above the relegation zone.
S&P has now relegated UK bonds all the way to the bottom of Football League One, which was once more accurately known as the Third Division. And, S&P's "negative outlook" means that the UK is in danger of being relegated to the Football League Two (or Fourth Division) of bond ratings like Shrewsbury which finished just above the relegation zone in Football League One in 2015-16.
Moody's Investor Services was a bit kinder. Moody's gave UK bonds a second-tier Aa1 rating before the 23 June referendum. And, Moody's has now attached a "negative outlook" to its UK rating. In other words, as far as Moody's is concerned, the UK was already down in the Championship League (once more accurately known as the Second Division) before the referendum and has now fallen to the level of Fulham near the bottom of that league just above the relegation zone.
Fitch Ratings sent the UK bond rating from second-tier AA+ before the referendum to third-tier AA after the referendum or from the Championship League down to Football League One.
For those who think bond ratings do not matter, see my earlier post for the case that rating agency and other financial market perceptions of a country do affect short- and long-term economic prospects. 
Today, 28 June 2016, UK Independence Party leader Nigel Farage spoke in the European Parliament and recalled Europeans laughing at him when he arrived in Brussels in 1999 telling everyone that his mission was to pull the UK out of the EU. He boasted that no one is laughing at him now. 
In my opinion, what British voters have done would be laughable if the consequences for Britain were not so sad. 
We shall see. Perhaps the rating agencies and I will be proven wrong by Farage and Boris Johnson and the rest of their motley crew. But, I do not expect to see the UK return to a S&P AAA bond rating during my lifetime.
Brexit voters can take comfort that the Dominion Bond Rating Service did confirm their top AAA rating for UK bonds the day after the referendum.

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