One of the world's premier rating agencies yesterday backed the UK's economy by maintaining its top credit rating, despite fears that the Government's cuts could send the country into a double-dip recession.
"Despite a weak post-crisis balance sheet and challenging economic outlook, the UK is able to meet these challenges whilst maintaining its Aaa credit rating," Moody's Investors Service said. It added that the UK also retained a stable outlook.
Kenneth Orchard, Moody's lead analyst for the UK, spelt out the problems facing the country's economy: "The global financial crisis of 2008 to 2009 caused serious long-term damage to the British Government's balance sheet. The country's economic outlook is also more challenging because private sector deleveraging, the uncertain state of the financial sector and slower growth in the UK's main trading partners are not conducive to allowing GDP growth to return to its pre-crisis trend rate."
Yet, the agency said it had handed the UK a stable rating following the Government's commitment to "stabilise and eventually reverse the deterioration in its financial strength. Government debt is also well structured, thus limiting refinancing risk."
This will come as a relief to the Government, which is to unveil its spending review next month.
The UK economy is flexible and robust enough to grow modestly over the medium term, the report added. It also expects the budget balance to be in surplus by 2014, with the overhaul of the banking sector only incurring moderate costs. Moody's backed the undervaluation in the currency to bolster net exports and the monetary policy expected to stay loose for some time.
Hetal Mehta, UK economist for Daiwa Capital Markets, said: "Moody's has given the green light to the UK Government in terms of its fiscal policy, they are confident that the Government is tackling the issues."
Moody's first assigned an Aaa rating to the Government's long-term debt in 1978, and the rating has remained unchanged since then.
A credit rating is essentially an indication as to how risky the agency thinks a debt issuer is. The higher the rating, the less likely it believes the issuer is to default. This rating will also allow the UK to borrow at the cheapest possible rates.
While the report was positive, it outlined where the rating could come under pressure. It said a combination of significantly slower economic growth, and reduced political commitment to fiscal consolidation "could prevent a stabilisation in debt ratios. A sharp rise in bond yields, possibly associated with an inflation shock or deterioration in market confidence, could also cause a worsening in debt affordability".
The economy could also face problems if the banking sector falls back into crisis, prompting further state support. The subsequent increase in budget deficit could see its Aaa rating sorely tested.
Last month, the British Chambers of Commerce warned that the scale and speed of the Government's spending cuts risked the prospect of a double-dip recession unless "accompanied by a coherent growth strategy".
The accountancy group BDO added last week that the Government's austerity measures could scare business into heavy cuts of their own. This, it said, could prompt a double-dip before the end of the year.
The same day, the TUC General Council said in a statement: "The new Government's reckless policy of rapid deficit reduction through unprecedented cuts to public services, procurement and investment not only pose a grave risk to the recovery but will irreparably damage our social fabric."
Daiwa's Ms Mehta said Moody's report yesterday was a more positive sign: "We believe the UK will avoid a double-dip recession even with all the cuts, but only just."
Fears of Irish crisis continue to mount
The Irish government must rethink its plans to bring the country's deficit down, the Governor of the Central Bank of Ireland warned yesterday, amid ongoing fears that the country might play host to a breakout of a new phase of the eurozone's sovereign debt crisis.
Patrick Honohan said that while Ireland's three austerity budgets had, at the time, left the country on target to hit European Union deficit rules by 2014, subsequent disappointing economic growth had undermined the progress.
"I think these kinds of budgetary pressures do need to be reprogrammed in the light of circumstances," Mr Honohan warned, though he said the cost of bailing out Ireland's banks still remained sustainable.
The cost of insuring against an Irish default on sovereign debt has risen sharply in recent weeks on speculation the country may eventually have to ask the International Monetary Fund for assistance.
Credit default swap spreads for Irish debt rose for the fifth day running yesterday, alongside measures of risk across the eurozone as a whole, which have also been increasing.
More positively, leading ratings agencies announced that they had awarded an AAA rating to the European Financial Stability Fund, the €750bn (£630bn) rescue vehicle set up by eurozone governments following the crisis in Greece earlier this year. The EC-controlled fund could step in were Ireland, or any other eurozone member, to lose the confidence of bond markets.