Markets set for sterling sell-off after AAA setback for Britain

Analysts expect pound to weaken against dollar and euro in response to Moody's decision
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Sterling was braced for a further sell-off today as financial markets geared up to respond to the decision of a major credit agency to strip the UK of its gold-plated rating.

The pound dipped to $1.5163 late on Friday in US trading, a two-year low, after Moody's announced it was downgrading British sovereign debt one notch from AAA to Aa1. The agency said that the move was a response to Britain's rising national debt and the poor growth outlook for the economy, which is teetering on the verge of an unprecedented triple-dip recession.

Asian and European financial markets will have their first opportunity to respond to the credit rating agency's decision today, with many analysts expecting sterling to weaken further against the euro and the dollar.

Simon Derrick , chief currency strategist of BNY Mellon, said Moody's decision would reinforce a "major shift" downwards for the pound. "[Sterling's] performance over the past twenty years has seen long periods of stability interspersed by sudden and dramatic revaluations or devaluations. Rarely have the trends been gentle," he said.

Andrew Sentance, a former member of the Monetary Policy Committee, pointed out that recent comments from senior policymakers at the Bank of England made it clear that they would welcome a lower exchange rate. "When policymakers seem to be talking down the pound it's a bit of a one-way bet for foreign exchange participants," he said.

Jim O'Neill, the head of Goldman Sachs' asset management arm, predicted that the downgrade would "add to sterling's weakness" but added that there was unlikely to be a collapse. "I'd say the impact will be more on domestic political debate than markets as most developed countries have already lost their AAA," he said.

The pound has been falling against the dollar and the euro for most of this year in response to the weakness of the domestic economy. The revelation last week that the Bank of England Governor recently voted for £25bn in more quantitative easing sent sterling lower on expectations of more money-printing by the central bank.

Ros Altmann, an economist and former head of the elderly pressure group Saga, argued that there could actually be benefits from Britain losing the top-notch credit rating if it prompted a rise in long-term interest rates. "Pension funds may benefit from loss of AAA if gilt yields rise and the pound falls," she said. "Assets and liability changes could reduce [pension funds'] deficits."

However, most economists doubt whether British government bond prices will fall dramatically in response to the downgrade. The US was stripped of its own AAA rating in 2011 by another agency, Standard & Poor's, and saw its borrowing costs decline. France's AAA was removed by two agencies in 2012 and has seen its borrowing costs steady. "There's just not that much choice now about where you invest" said Robert Wood of Berenberg Bank. Similarly, few analysts are worried about a shares sell-off. "From an equity market viewpoint the move to downgrade by one very small notch will most likely be seen as a relief," said Howard Wheeldon of Wheeldon Strategic Advisory.

Investors fear Berlusconi comeback

European bond investors are eyeing the Italian elections nervously, fearing that a strong performance by former Prime Minister Silvio Berlulsconi's centre-right party today could re-open the eurozone sovereign debt crisis. "People are heading into the election a bit more cautious. There was a lot more selling last week and a defensive stance," said the UBS currency strategist Geoffrey Yu. "The Italian elections top our list of risks as to what could still upset the progress in the eurozone," said Holger Schmieding of Berenberg Bank.