UK debt outlook cut from ‘stable’ to ‘negative’ by Fitch: What does it mean?

The outlook for Britain’s government debt was lowered from ‘stable’ to ‘negative’ by Fitch yesterday as the New York rating agency reacted to the Chancellor’s ‘unfunded fiscal package’.

Fitch cited the government’s “weakened political capital” to justify the change and warned Kwasi Kwarteng’s poorly received mini-budget could lead to a “significant increase in budget deficits in the medium term.”

The agency also pointed to the lack of an independent forecast from the Office for Budget Responsibility and an apparent clash with the Bank of England’s strategy to fight inflation.

Fitch said: “While the government reversed the abolition of the top-rate tax of 45 pence … the government’s weakened political capital could further undermine the credibility of and support for the government’s fiscal strategy.”

Just days earlier, Fitch’s rival Standard & Poor’s threatened a credit cut on UK debt after the country granted a ‘negative outlook’ in the wake of Kwarteng’s tax event.

The late September mini-budget plunged sterling’s value against the US dollar and sent government bond yields – gold-plated bonds – skyrocketing, with the Bank of England having to intervene after it fell to a potential crisis in the pensions market.

While Fitch and S&P maintained their credit ratings at AA and AA respectively, the change in outlook is another headache for the government as the move weighs on investors’ perceptions of the risks of UK debt and thus the compensation they demand in exchange for buying it.

Fitch, S&P and Moody’s are the three major credit rating agencies that have to assess how likely a borrower is to repay its debt.

This information is used to help those who buy or sell existing debt, such as gilts.

Lowering a country’s rating means that the rating agency is slightly less confident that it will be able to pay its existing debt, most likely because it believes the country’s economic prospects have weakened.

A country whose rating has been downgraded may see the cost of borrowing rise – lenders will want higher interest rates to match the increased risk.

The UK’s credit rating was downgraded three steps from AAA to AA2 by Moody’s in 2017 after Theresa May’s government scaled back the austerity drive of former Chancellor George Osborne.

Moody’s also pointed to the economic risks of leaving the European Union for the world’s fifth largest economy at the time.

Gilts went on sale again on Thursday, bringing two-year, five-year, 10-year and 30-year yields to 4.3%, 4.1 and 4.3 percent, respectively, by midday.

Treasury bond yields remain below their levels in the immediate aftermath of the mini-budget, but are well above their levels for most of this year, as they hovered around 1 percent in 2022.

Susannah Streeter, senior investment and market analyst at Hargreaves Lansdown, said: [Conservative Conference] Yesterday’s speech had nothing new to put the markets at ease and with growing political divisions within her party over how to pay for major tax cuts, rating agencies are far from impressed.

Fitch followed S&P to downgrade the outlook for the UK’s AA investment grade rating from stable to negative.

This matters because even without a write-down, the UK’s borrowing costs have risen sharply, and if the ‘stable’ rosette is ripped off, foreign creditors will demand even more money to finance the government’s growing mountain of debt. Moody’s has also warned that major unfunded tax cuts could hurt the debt sustainability of the country.”

Streeter added that government bond yields are “rising again” despite the BoE’s intervention and that if they continue to rise, the bank “may need to dive back into bond buying.”

Head of Investments at Interactive Investor Victoria Scholar said: ‘There are serious concerns about the government’s unfunded stimulus measures and what the increased levels of borrowing will mean for the UK’s inflationary conundrum and for its debt levels.

“The UK is already dealing with historically high debt in the wake of the pandemic, when billions were spent on expensive emergency programs such as the leave scheme, track and track and vaccine roll-out.”