Introduction: Fitch cuts outlook for UK rating to ‘negative’ from ‘stable’
Good morning, and welcome to our rolling coverage of business, the world economy and the financial markets.
A second rating agency has threatened to downgrade the UK’s credit rating, warning that the unfunded tax cuts in Kwasi Kwarteng’s mini-budget will drive up borrowing.
Fitch has cut the outlook on the UK’s AA- investment grade credit rating, to Negative from Stable, following a similar move from S&P.
Fitch warned that the “large and unfunded fiscal package” could lead to a significant increase in the government’s deficits over the medium term, and undermine the previous government’s fiscal consolidation strategy.
In a rather scathing verdict of Kwarteng and Liz Truss’s plans, Fitch says:
The large fiscal stimulus, announced without compensatory measures or an independent evaluation of the macroeconomic and public finances’ impact, and the inconsistency between fiscal and monetary policy stance given strong inflationary pressures, have in Fitch’s view, negatively impacted financial markets’ confidence and the credibility of the policy framework, a key long-standing rating strength.
Fitch also criticises Kwarteng for hinting that there could be more tax cuts, and fears the government’s politicial credibility, and the credibility of its fiscal policy, are both hurt.
Monday’s humiliating u-turn on abolishing the top rate of UK income tax didnt change Fitch’s wider assessment either:
Although the government reversed the elimination of the 45p top rate tax (expected to cost £2bn in FY22-2023), the reportedly negative impact of the tax package, and related financial market volatility, on public opinion and the government’s weakened political capital could further undermine the credibility of and support for the government’s fiscal strategy.
Fitch estimates that “without compensatory measures”, the general government deficit will remain elevated at 7.8% of GDP in 2022 and increase to 8.8% in 2023.
Borrowing will be pushed up by rising interest payments on inflation-linked bonds, household support packages, the energy price cap and tax cuts.
This would lift the UK government debt to 109% of GDP by 2024 from an estimated 101% in 2022, reflecting “both higher primary deficits and a weaker growth outlook”.
Also coming up today
National Grid is set to publish its outlook for both gas and electricity supplies this winter today, outlining how Britain’s power system will cope with harsh weather.
The report comes amid growing concern that factories could be forced to shut down as Vladimir Putin chokes Europe’s gas supplies.
We also find how UK, and eurozone, construction companies fared last month, and the Office for National Statistics releases its weekly economic insights.
The agenda
-
7am BST: German factory orders for August
-
8.30am BST: Eurozone construction PMI for September
-
9.30am BST: UK construction PMI for September
-
9.30am BST: ONS’s latest economic activity and business insights
-
12.30pm BST: European Central Bank’s Monetary Policy Meeting Accounts published
-
1.30pm BST: US weekly jobless claims
Key events
Filters BETA
Although Fitch are the second ratings agency to cut the UK’s outlook (after S&P), Moody’s was also concerned about the mini-budget.
Moody’s warned last week that the large unfunded tax cuts were “credit negative”, and would lead to higher deficits. It is expected to give its verdict on the UK on 21st October.
UK bond prices are a little weaker this morning, which is pushing up the interest rate on government debt.
Benchmark 10-year government bond yields have risen to 4.08%, from just over 4% last night.
Before the mini-budget, these 10-year gilts were trading at a yield of 3.5%, before Kwasi Kwarteng’s plans for unfunded tax cuts alarmed markets.
They surged to 4.5% last week before the Bank of England pledged to buy up longer-dated bonds to stabilise the markets and protect the pensions industry.
The yield on 30-year gilts has risen to 4.26%, from 4.18%. They also rose yesterday after the Bank of England resisted buying any gilts through its emergency scheme, following the recovery in bond prices.
How to avoid a credit rating downgrade
Lowering the UK’s outlook to negative, from stable, could be the first step towards a full-blown downgrade by Fitch.
Fitch say there are several factors that could trigger a cut… or alternatively lead to an upgrade.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
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Public Finances: Failure to implement a credible fiscal strategy that restores market confidence and is consistent with government debt/GDP declining over the medium term.
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Macro: Evidence that policy uncertainty and/or new trading arrangements with the EU will undermine the UK’s macroeconomic performance and financial stability over time.
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-Structural: Political developments that lead to deterioration in governance indicators and/or undermine the territorial integrity of the UK.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
-
Public Finances: Implementation of a credible fiscal strategy that is consistent with government debt / GDP declining over the medium term.
-
Macro: Reduces risks to macro-financial stability, for example, through sustained easing of inflationary pressures and improved market confidence in the government’s fiscal strategy.
Some history: the UK lost its prized AAA credit rating with both Fitch and Moody’s back in 2013, while S&P followed suit after the EU referendum in 2016.
Fitch also downgraded the UK after the Brexit vote (from AA+ to AA), and then lowered the rating to AA- when the pandemic hit.
As the FT points out, the ratings agencies are still monitored by investors:
Credit rating agencies have lost some of their power since the 2008-09 financial crisis, when they failed to warn of the risk in many complex products they had given triple-A ratings.
But their sovereign ratings are still closely watched.
Political uncertainty is also weighing on the UK, Fitch adds.
The new government of Prime Minister Liz Truss has sought to assuage concerns regarding transparency and institutional independence after comments about potential revisions to the BoE’s mandate during the Conservative leadership contest and the roll-out of a large fiscal package without the involvement of the Office of Budget Responsibility.
Reduced popular support for the ruling Conservative Party, the social impact of the cost of living crisis and increased frequency of strikes could constrain the new Prime Minister’s room for manoeuvre.
Polling company YouGov showed yesterday that Truss’s popularity had deteriorated dramatically, while several polls have given Labour very large leads since mini-budget.
Fitch: UK economy to contract next year
Fitch has also warned that Britain’s economy will shrink next year, despite the mini-budget.
We forecast the economy to contract in 2023 despite the energy tariff support and the proposed tax cuts. In addition to the energy crisis and weaker external demand (including contraction in the eurozone), the likely tighter domestic financing conditions will lead to a contraction of 1.0% in 2023 before growth recovers to 1.8% in 2024.
Yesterday, Liz Truss claimed that an “anti-growth coalition” was holding the UK back – including opposition parties, unions, remainers and environmental campaigners (and quite possibly anyone who disagrees with the government).
Fitch, though, points out that Truss’s administration haven’t shown how their growth plan will actually improve the economy:
Although the government seeks to lift growth to 2.5% over the medium term, it has yet to fully outline how and in what timeframe it plans to directly address structural challenges related to low investment, labour supply and continued uncertainty over the implementation and evolution of the Trade Cooperation Agreement (TCA) with the EU.
There could be progress on that last point soon — Simon Coveney, the Irish foreign minister, is flying to London for talks with his UK counterpart, James Cleverly, today over Northern Ireland’s Brexit arrangements.
Chancellor to hold crisis talks with high street banks over rising mortgage rates
Fitch’s warning comes as Chancellor Kwasi Kwarteng prepares to meet high street bank bosses to discuss the crisis in the mortgage market following the mini-budget.
The talks comes as homeowners face the biggest increase in mortgage costs for 14 years, with the average rate on a new two-year fixed mortgage rising above 6%.
These soaring rates mean some homeowners’ monthly payments are increasing by hundreds of pounds a month when they remorgage, and are also pricing new home-buyers out of the market.
My colleague Rupert Jones explains:
Moneyfacts, a financial data provider, said the average new two-year fixed rate had risen again and broken through 6% on Wednesday. It went up to 5.97% on Tuesday, having already risen to 5.75% on Monday.
The average two-year fix has increased from an average of 4.74% on 23 September, the day of the mini-budget. At the start of December last year the average was 2.34%.
Mortgage costs surged as the money markets dramatically lifted their forecasts for UK interest rates after the mini-budget.
This morning, the money markets suggest the Bank of England will have hiked base rate to 5.5% by next summer, from 2.25% today.
Introduction: Fitch cuts outlook for UK rating to ‘negative’ from ‘stable’
Good morning, and welcome to our rolling coverage of business, the world economy and the financial markets.
A second rating agency has threatened to downgrade the UK’s credit rating, warning that the unfunded tax cuts in Kwasi Kwarteng’s mini-budget will drive up borrowing.
Fitch has cut the outlook on the UK’s AA- investment grade credit rating, to Negative from Stable, following a similar move from S&P.
Fitch warned that the “large and unfunded fiscal package” could lead to a significant increase in the government’s deficits over the medium term, and undermine the previous government’s fiscal consolidation strategy.
In a rather scathing verdict of Kwarteng and Liz Truss’s plans, Fitch says:
The large fiscal stimulus, announced without compensatory measures or an independent evaluation of the macroeconomic and public finances’ impact, and the inconsistency between fiscal and monetary policy stance given strong inflationary pressures, have in Fitch’s view, negatively impacted financial markets’ confidence and the credibility of the policy framework, a key long-standing rating strength.
Fitch also criticises Kwarteng for hinting that there could be more tax cuts, and fears the government’s politicial credibility, and the credibility of its fiscal policy, are both hurt.
Monday’s humiliating u-turn on abolishing the top rate of UK income tax didnt change Fitch’s wider assessment either:
Although the government reversed the elimination of the 45p top rate tax (expected to cost £2bn in FY22-2023), the reportedly negative impact of the tax package, and related financial market volatility, on public opinion and the government’s weakened political capital could further undermine the credibility of and support for the government’s fiscal strategy.
Fitch estimates that “without compensatory measures”, the general government deficit will remain elevated at 7.8% of GDP in 2022 and increase to 8.8% in 2023.
Borrowing will be pushed up by rising interest payments on inflation-linked bonds, household support packages, the energy price cap and tax cuts.
This would lift the UK government debt to 109% of GDP by 2024 from an estimated 101% in 2022, reflecting “both higher primary deficits and a weaker growth outlook”.
Also coming up today
National Grid is set to publish its outlook for both gas and electricity supplies this winter today, outlining how Britain’s power system will cope with harsh weather.
The report comes amid growing concern that factories could be forced to shut down as Vladimir Putin chokes Europe’s gas supplies.
We also find how UK, and eurozone, construction companies fared last month, and the Office for National Statistics releases its weekly economic insights.
The agenda
-
7am BST: German factory orders for August
-
8.30am BST: Eurozone construction PMI for September
-
9.30am BST: UK construction PMI for September
-
9.30am BST: ONS’s latest economic activity and business insights
-
12.30pm BST: European Central Bank’s Monetary Policy Meeting Accounts published
-
1.30pm BST: US weekly jobless claims
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