Moody's, one of three 'Credit Ratings Agencies' has downgraded the UK governments credit standing from AAA (the best rating meaning 'very safe' to lend to) to AA1 (meaning 'pretty much safe' to lend to).
So what difference does this make? All loans require a rate of interest to be paid. The rate charged is made up of several elements, such as a 'pure' element - the profit to the lender - an 'inflation protection' element - the lender gets back what they lent in real terms - and a 'risk of default' element. The last one means the premium charged to protect the lender against the chance of not being repaid. The credit rating is about that element. When a country or firm has a AAA rating then this element can effectively be zero; there is no risk of default.
To the extent that the UK government will always repay its debts then there is no risk of default. So AA1 shouldn't really make a difference to lenders. But if it did and lenders started demanding higher interest rates then this will increase the already significant interest rate bill to be paid by taxpayers each year (currently about £50 billion).
Further if the government has to pay more to borrow so will everyone else. Lenders will be attracted to lend where rates are highest. To get them to lend to mortgage borrowers the interest rate will also have to rise, otherwise they will lend their money to safe governments. So, as the Chancellor has been at pains to point out, the government paying more interest affects all borrowers.
If firms and consumers have to pay higher interest rates then Consumption and Investment will not rise as fast as hoped and recovery will be further delayed.
Ed Balls blames the government and says it is all their fault for not borrowing more. If they had done then the economy would have grown faster and this problem would have been avoided. (Moody's blame slow growth for the downgrade).
The Chancellor says had the government not cut the deficit (well tried to) then this downgrade would have come much sooner.
It is not clear which version of events is right. Balls has the problem that a credible deficit reduction plan is essential to keep the credit rating and must contend with the ineffectiveness of stimulus policies generally. Osborne faces a rising deficit and missed targets with very poor growth.
Whoever is right the downgrade will make little difference in reality. France and the USA continue to borrow at record low interest rates despite being downgraded already. Two of the three rating agencies have not yet downgraded the UK.
Perhaps the most obvious point to make is that these same rating agencies stamped the mortgage backed securities that turned out to be worthless and caused the Global Financial Crisis 'Triple A'. Their credibility is pretty low and one of them is currently being taken to court by the US government for their role in misleading investors.
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The real problem is that Osborne placed such high premium on the AAA rating, and he set it up to be the test for his economic policy and yet he is the first Chancellor to lose Britain its AAA rating since 1978. The reason why this is coming back to bite him is because he said kept on making out that the only reason for his economic policy, was because Britain would lose its AAA rating and the bond markets would lose confidence in our ability to pay down our debts meaning higher interest rates etc.
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