UK Credit Rating Downgrade Impact

UK Credit Rating Downgrade Impact.

Leading credit ratings agency Standard & Poors and also Fitch has reduced the UK’s credit rating from AA+ to AA i.e. their opinions of the UK being able to repay its debts.  In addition, another credit rating agency, Moody’s reduced its outlook for the UK to negative.

Understandable we suggest, but what does this mean for the UK?

It means that the UK may have to pay more to borrow money.  Up to Brexit, the UK enjoyed one of the lowest yield requirements for government debt as we are perceived as a stable economy alongside the likes of the US, Canada, Germany. 

Every month or so the UK Debt Management Agency has an auction for the amount of money the government needs to borrow.  Depending upon the stability of the country (e.g. Greece had to pay much higher interest rates), the money will be lent by institutional investors such as banks and pension funds effectively buying shares in UK Government Plc.  These securities are known as “Gilts” (gilt edged securities back by the British Government).  In other countries they are now as government bonds.

If interest rates on gilts need to rise, because investors want more money for the perceived higher risks, then this may impact elsewhere.

Impact of Increased Gilt Yields

Investment Funds

Increased gilt yields will reduced the capital values of fixed interest funds.

Pension Annuities

Annuities are usually linked to Gilt yields.  In short, if a pension company guarantees to give you a fixed income, in retirement, for life, it takes on that liability whether markets rise or fall.  To protect themselves, pension companies usually buy gilts (a source of fixed and inflation linked income stream) that they use to then fund your pension income.  If gilt yields rise, pension annuity rates my rise.

In the short term, we do not expect gilt yields to rise as people are looking for safe haven investments, but in the medium term we do expect some increases in the cost of borrowing for Uk government.