X rating

Private investors may well be wondering what the fuss over the UK’s credit rating is all about. It will probably all blow over but the doubts over UK national debt are another reason to be cautious about the stock market recovery.

The esoteric world of the credit rating agencies passes most of us by. Indeed the ratings agencies themselves have taken quite a bit of stick because they failed to spot the warning signs in the financial sector and were blithely issuing high ratings to banks that subsequently collapsed.

One of the biggest international ratings agencies is Standard and Poor's, which has caused a stir by effectively warning that it could downgrade its rating on the UK. Our sovereign debt--that is the money owed by the government--is currently rated AAA, the top rating, so any change can only be for the worse.

Note that S&P has not changed this rating. It is merely warning that it is now keeping a watchful eye on the situation rather than maintaining its previous stance of blithe optimism.

It is possible that ratings agencies are being more cautious, to avoid being caught out again. These agencies have been accused of overoptimism in the past, particularly in assessing company debt, for fear of losing business from disgruntled clients (in the same way that auditors are accused of signing off accounts too readily because their clients pay for other lines of business).

Not all debt that is put on ‘outlook negative’ is subsequently downgraded. In most cases the shadow is subsequently removed. However, Japan, Ireland and Spain have all been downgraded in the global financial turmoil.

Even if we are downgraded, we shall be rated AA instead of triple A, which does not sound too much of a step down. We would still have A and A minus to go before the dreaded drop down to the B league.

However, we should not be complacent over the outlook for UK debt. Remember, if the government gets into financial difficulties the effects will screw up the whole economy. We have already seen how the mess in the banking sector has had a massive impact, so imagine what it would be like if the government went bust.

The cause of the potential downgrading is also the reason why it would be so unfortunate should it happen. The bailout of the banking system, combined with a slowdown in the economy, could mean that national debt reaches the equivalent of an entire year’s output in goods and services. The government borrowed £8.5 billion in April, which is usually a good month for company taxes flooding in.

If UK debt is downgraded, then the cost of borrowing will edge higher as lenders take a more cautious view, possibly not by a lot but enough to add to the already increased burden of interest payments on the national debt.

It seems likely that S&P will not actually downgrade the UK until after the next general election, which is still nearly a year away. Despite all the furore over MPs’ expenses and the calls for an immediate clear out of the House of Commons, Gordon Brown will delay the ignominy of being turfed out until the last minute, as John Major did.

Meanwhile the UK economy itself continues to give off conflicting signals and it is important not to put too much store by just one month’s figures. It does look as if the housing market has bottomed but improvements are coming from a low base and look erratic. Similarly, one good month in the High Street is followed by a setback.

The car scrappage scheme, under which the government and car manufacturers each contribute £1,000 to the cost of a new car, has made a better start than most people, including myself, expected. It seems that 35,000 old cars have been crunched since the scheme started in April, accounting for about one in five of new cars purchased.

However, these are early days. It is quite possible that most motorists qualifying for the scheme rushed to cash in while they had a chance and that numbers will dwindle quite rapidly. In any case sales of new cars fell 28.5% in the first four months of 2009 compared with the same period of 2008.

This question mark over the nation’s finances will loom large over any stock market recovery. We have once again seen the Footsie stumble above 4,400 points. The ceiling has not been broken yet.