The British economy may get officially downgraded – this is no time for panic

By Duncan Weldon

S&P, the ratings agency, has placed the UK’s AAA bond rating on ‘negative outlook‘. This means they are ‘considering’ downgrading it in the future. The full S&P statement is here.

In the context of the large expected rise in public sector debt, this is not surprising.

First off – let’s not panic.

They are talking about moving us, at some point in the future, to AA, the second highest rating. They are not saying we are heading for bankruptcy/the IMF whatever. Let’s keep some perspective.

Second, at 10.30am this morning (after the negative outlook), there was bond auction. We sold £4.5bn of 5 year gilts at an average interest rate of only 2.91%. Clearly the markets are not as paniced as the right is about to suggest they are. We received £13bn of bids, in other words there were plenty of people willing to lend to us.

Third, it’s worth reading the actual S&P release (my emphasis):

“We note that there is support across the political spectrum for additional fiscal tightening. However, the parties’ intentions will likely remain unclear until the next administration is formed after the general election, due by mid-2010. How quickly the government can stabilize and then reduce the government debt burden will also depend on the timing and shape of the economic recovery and whether the cost of government support of the banking system is higher than we currently assume, areas where we also see continued downside risks.

The rating could be lowered if we conclude that, following the election, the next government’s fiscal consolidation plans are unlikely to put the U.K. debt burden on a secure downward trajectory over the medium term,” Mr. Beers said. “Conversely, the outlook could be revised back to stable if comprehensive measures are implemented to place the public finances on a sustainable footing, or if fiscal outturns are more benign than we currently anticipate.”

This downgrade, if it happens, will not happen until after the election. At that point it will be imperative for the government to set out a credible plan to return the finances to balance, I favour doing it mainly through tax rises, the Tories through mainly spending cuts. Either way, the new Government will be forced to act very quickly in setting out plans.

I am not trying to ignore the significance of all this. But let’s keep some perspective.