Moody’s Investor Services lowered UK debt from Aa1 to Aa2 on Friday evening.

That is a move from the second to third highest score in the firm’s 21 rating scale, and the UK remains an “investment grade” borrower by a wide margin.

Nevertheless, the ratings agency stated on 22 September:

“Moody’s expects weaker public finances going forward, partly linked to the economic slowdown under way but also reflecting the increasing political and social pressures to raise spending after seven years of spending cuts.”

Referring to the lack of agreement about Britain’s lack of a post-Brexit deal with the EU, the credit agency wrote:

“Moody’s believes that the UK government’s decision to leave the EU single market and customs union as of 29 March 2019 will be negative for the country’s medium-term economic growth prospects. Aside from the direct impact on the UK’s credit profile, the loss of economic strength will further exacerbate pressures on fiscal consolidation.”

The firm later added:

“Moody’s is no longer confident that the UK government will be able to secure a replacement free trade agreement with the EU which substantially mitigates the negative economic impact of Brexit. While the government seeks a “deep and comprehensive free trade agreement” with the EU, even such a best-case scenario would not award the same access to the EU single market that the UK currently enjoys. It would likely impose additional costs, raise the regulatory and administrative burden on UK businesses and put at risk the close-knit supply chains that link the UK and the EU. Also, free trade arrangements do not as a standard cover trade in services -- which account for close to 40% of the UK’s exports to the EU and 80% of Gross Value Added in the economy -- given the prevalence of non-tariff trade restrictions and the need to align regulations and standards. In Moody’s view, the differences of outlook between the UK and the EU suggest that the most likely outcome is now a rather more limited free trade agreement which may exclude services: the UK’s desire to pursue its own regulatory policies and to avoid the jurisdiction of the European Court of Justice will make finding an agreement on services challenging. Moreover, any free trade agreement will likely take years to negotiate, prolonging the current uncertainty for businesses.”

The British government responded within an hour of Moody’s announcement, the Financial Times reported on 23 September, with the Treasury writing in a statement:

“The assessments made about Brexit in this report are outdated. The prime minister has just set out an ambitious vision for the UK’s future relationship with the EU, making clear that both sides will benefit from a new and unique partnership.”

Indeed, Moody’s downgrade came a few hours after Theresa May, the British prime minister, speaking in Florence, Italy, proposed a two-year transitional phase where EU rules would mostly still apply in her country after Britain leaves the bloc in March 2019.

In addition, the UK would like to strike a bespoke deal with Brussels, EUobserver reported on Friday:

“On the long-term relationship, May said she wanted a free trade deal with the EU that was more ambitious than the EU’s agreement with Canada, but ruled out being bound by EU law in return for access to the single market on the model of Norway.”

Luxembourg rating

Separately, DBRS, another major credit ratings agency, reaffirmed its top-notch AAA grade on the grand duchy’s public debt.

DBRS said in an announcement on 22 September:

“The rating reflects Luxembourg’s sound public finances, its solid institutions and political environment, its wealthy and advanced economy, and its strong external position. These credit strengths counterbalance the challenges associated with the country’s relatively limited degree of economic diversification, its vulnerability to external shocks, possible changes in tax frameworks in Europe and the US, and potential pressures in the residential real estate market.
“The Stable trend reflects Luxembourg’s strong economic fundamentals and DBRS’s view that the challenges Luxembourg faces are manageable. Despite potential risks of financial market volatility, the economy is expected to continue growing at a strong pace. Although the recently-adopted tax reform is set to reduce the fiscal space, public finances are also expected to remain sound, supported by a robust fiscal framework.”

“Luxembourg also exhibits one of the lowest government debt levels in Europe,” according to the DBRS announcement, issued after the financial markets closed on Friday.

Standard & Poor’s, also a global ratings agency, reaffirmed its highest rating (AAA) on Luxembourg public borrowing on 15 September.

Generally speaking, a lower rating increases the cost of borrowing in the capital markets. In addition, many institutional investors are required to only hold bonds above a certain grade.