The credit rating agency Fitch has recently downgraded their credit rating of the UK from AA to AA- because of the impact of the Corona virus and continued uncertainty about Brexit. Fitch believe economic output will drop 4% this year in the UK. Their concerns are summed up as being due to “the deep near-term damage to the UK economy caused by the coronavirus outbreak and the lingering uncertainty regarding the post-Brexit UK-EU trade relationship”.
Why do credit ratings matter? Well, a credit rating is a judgement as to the creditworthiness of a borrower, or in this case the United Kingdom as an issuer of government debt in the form of Gilts. In simple terms, the higher the credit rating, the more likely creditors are to receive not only the interest on their loans but also any interest due. If the risk of default is higher, investors will demand a better return – the so-called risk premium. This means in essence that it becomes more expensive for the UK to borrow money. Additionally, a country that is seen as risker will find it less easy to attract Foreign Direct Investment (FDI).
Traditionally, sovereign debt, such as UK Gilts or US T-Bonds are seen as ‘risk free’. UK gilts have just become a bit riskier. This is not good news for the UK, but it may attract investors who are looking for a better return (the risk premium), though traditionally most buyers of government debt do not want any excitement. Boring, stable and consistent returns may not sound fashionable, but in these uncertain days, they are likely to be popular.