In May 2009 I put up a post where I wholeheartedly agreed with Stuart Cheek, head of UK Government bonds at BGC Partners, that the UK's credit rating being downgraded to anything but AAA would be a very, very big deal. Here
At the time, the rating agency S&P were saying that the UK government had too much debt, but even more importantly, they were running too big of a deficit so the debt was growing much too quickly. They said that if the incoming government (this was way before the UK general election of course) were not able to demonstrate they were going to very quickly deal with and reduce the deficit and also the outstanding debt level, then the credit rating would be downgraded.
Since then of course we have elected the coalition Con-Dem government. There has been much noise and fanfare about the "cuts" they are imposing on the public sector finances. My own view is that actually all they are proposing to "cut" so far is the size of the spending increases -- I don't think you will find on close inspection that the public spending bottom line is going to be smaller at all. Most certainly, it is not going to be MEANINGFULLY smaller, such that there will be not only no deficit (some hope!) but actually some kind of dent being made into the outstanding national debt. We will still be running a significant budget deficit (adding to the national debt), no matter how savagely the Con-Dem government take the axe to the public budgets. Labour have simply run the finances into the ground and there is no way in hell we can ever pay off these levels of debt, with honest money.
No, I still see us running a large budget deficit, quantitatively easing more Pounds into the financial system to help paper over the problem, and receiving a credit rating downgrade to something below AAA. This will still be a massive problem, as many investment funds must hold securities that are only of AAA credit quality. Those investment funds will have no choice but to sell off the non-AAA government bonds if this downgrade does indeed come to pass, and more supply = lower prices. When it comes to bonds, lower price = higher yield. Higher yield is just another way to say higher interest rate.
It's instructive to also today see the Chinese already having downgraded our credit rating, along with almost all of the developed world. (See the link to that article on the Facebook fan page.)
It seems today that S&P wish to reiterate what they said a year ago, according to an article in the Telegraph (link follows). Perhaps it is a simple reminder that the government needs to be extremely serious indeed about dealing with the out of control public sector budget. Perhaps it is a matter of maintaining their own credibility, in the face of the Chinese rating agency now already having taken this action.