Credit rating downgrade - does it matter and who does it help?

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.

The BBC covers the story here, but look at the website directly to cover latest updates.

End of recesion or just heading for VW?

People often talk about the shape of a recession. The 'best' is V shaped - a short and sharp drop in GDP with a rapid recovery. U shaped is second best, still a strong recovery. The dreaded L shaped is the one to avoid and the reason why the policy response was so robust in 2008/9.

The UK has now officially reached the end of the W shaped - double dip - recession. Feared for so long and lengthened by the one-off impact of the Jubilee. Officially the UK grew by 1% in the quarter July to September, the fastest growth for five years.

Actually there were special considerations for this growth spurt, mainly the Olympics and the 'catch-up' from the previous quarter, so don't get too excited yet.

The headline figure is, as always, hiding a lot of detail. Look at the BBC economy page for that. It should be noted that the construction sector really is the problem area at present.

Construction continues to shrink and is making a really big impact on the figures. We should be worried about this. Not only does construction employ a lot of people and use lots of locally produced resources, but it is also a 'leading sector' in recoveries. We would expect construction to turn up before we saw a sustained rise in Real GDP.

The other point that might be worth noting is that the economy shrank by 6.4% in the first 'dip' and so far only half of that has been recovered even counting the last quarters growth.

Below is an article by The Guardian's Larry Elliott. You could not find a more miserable and biased economic commentator and he puts the latest recovery in the worst light he can. I'm surprised he wasn't the first to name the next stage as the triple dip or VW shaped recession. Glad I got in first!

Elliott's article is here

The case for Plan A

Yesterday the Conservatives put the argument for continuing their plan to reduce the government budget deficit in the strongest terms for over a year.

Fundamentally there is on two types of news on the economy, bad and absolutely awful. Given that the government might as well take it on the chin and express their beliefs.

George Osbourne, The Chancellor, said he would find more money through benefit cuts. This plays surprisingly well outside of the Conservative Party with the general public. It remains to be seen if it can be done and whether people will accept the reality.

The Prime Minister asserted the cuts will continue, despite the growth forecast for the UK by the IMF being cut. (Well we all knew that!). He pointed out that one million new private sector jobs have been created and this is compensating for public sector cuts.

The government argues that the deficit needs to be reduced to avoid problems in the future. The Opposition says a boost is needed to get the economy growing again.

The IMF says that a short term stimulus might be appropriate, but that the markets will take fright on any large scale and longer term rise in spending that will raise the deficit. So some support for both sides there.

One issue that is clear is that the government has not reduced the deficit as far as they wanted to. This shows just how difficult it is to cut spending. Good luck with the plan George.

The Independent cover the current issues here