Fisher Investments Editorial Staff
Others

A Not So Sterling Warning

By, 06/09/2010

Story Highlights:

  • Fitch warned the UK to control its budget or risk losing its AAA credit rating.
  • Despite the warning, Fitch kept the UK rating "stable," an indication it won't likely cut it any time soon.
  • Britain's fiscal health is little changed, recent economic data has been mostly more positive than expected, and a new budget is just two weeks away.
  • It's unclear what Fitch stands to gain from the report, unless they're playing politics—but for an "impassive" third party, that would be strange.
  • Whatever their reasoning, if nothing else, the last few years should have taught investors to skeptically view credit ratings billed as objective analysis.

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Fitch again warned the UK to control its budget Tuesday or lose its AAA credit rating. Though the firm kept its UK rating "stable," indicating it won't likely cut it any time soon, the report rattled European markets and sent sterling lower. (US stocks ended higher on the day.) Given recent positive economic data and a reworked budget pending, Fitch's timing and tone seem a bit strange.

While it's not all roses for the Brits, recent data have been mostly better than expected. Just last week the May UK manufacturing purchasers index (PMI) beat expectations by holding steady at April's 15-year high of 58.0 (over 50 indicates expansion). Meanwhile, UK services PMI increased to 55.4 from April's 55.3, just missing expectations. PMI surveys industry executives, aggregating their reports on business activity each month—expansionary PMI often translates into wider expansionary economic data.

And while Fitch's report casts a shadow on UK sovereign debt, investors think otherwise. Long-term UK bond yields have been falling along with US and German yields. Investors still view dreary old London as a relatively safe place to park cash. And for good reason, the UK has a big, diverse economy—little resembling other debt-strapped European countries like Greece.

If it's not the economy or jumpy credit markets, then it must be some new ill-advised policy, or a slew of new spending. But Fitch shreds the deposed Labour government's budget—which is soon to be obsolete. A new Conservative/Liberal Democrat replacement budget is due in just two weeks. All signs point to considerable fiscal tightening. The coalition already announced £6 billion in spending cuts, with more undoubtedly to come.

With little deterioration in economic statistics and a more meaningful, likely fiscally tighter, budget on the way, why not wait to issue their outlook? Some analysts suggest Fitch's report will soften the British public to fiscal cuts if they're backed by an "uninterested" third party. That's funny, and more than a little contradictory. If Fitch is so "impassive," what do they care if the UK is successful in implementing a tough fiscal policy?

The last few years should have taught investors to skeptically view credit ratings billed as objective (verging on divine) gauges of credit health. They are opinions, no more, from a government-enforced oligopoly. Such warnings likely little influence markets further out, but unfortunately can unnerve them in the near term—particularly amid a correction, when inconsequential news makes big headlines.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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