Now Britain is dependent on the kindness of strangers….
By Ambrose Evans-Pritchard
Britain is in danger of misreading the political landscape in Europe and faces the possible loss of its reserve currency status if it fails to secure full access to the European single market, Standard & Poor’s has warned.
The powerful US rating agency said the British government is treading into hazardous waters in negotiations with the EU and is risks serious damage to economy’s future growth trajectory, with long-term implications for the debt profile and the country’s credit-worthiness.
S&P fears that loss of unfettered access to the single market would have incalculable consequences for business, yet the Government so far appears almost insouciant about this.
“There seems to be this view that ‘we’re a big important economy, the Europeans export a lot to us, so they have got to give us what we want’, but is that really true?” said Ravi Bhatia, the director of sovereign ratings in charge of Britain.
Theresa May’s key quotes on BrexitPlay!01:56
“Individually most of these countries don’t export that much to the UK, and were seeing a hardening of attitudes,” he said.
Mr Ravi said Britain has limited scope for a spree on infrastructure projects and is walking a fine line on budget policy. “Before Brexit, the trajectory was planned fiscal consolidation, but we’re no longer certain we’re going to see that,” he said.
“If they ramp up fiscal spending they’ll get a stimulus and that is good in one way as it will help boost growth, but they have to finance that spending; it will raise the deficit, and the debt stock is already high,” he told the Daily Telegraph.
Standard & Poor’s stripped Britain of its AAA status immediately after the Brexit vote in June, slashing the rating by two notches to AA, although the move was well-flagged in advance. It described the vote as seminal event that would lead to a “less predictable, stable, and effective policy framework in the UK”.
The agency will issue its next verdict at the end of this month.
Any further downgrade at this delicate juncture would be more serious, amounting to a red card on the Government’s hard-nosed rhetoric and negotiating tactics
It is unprecedented for a AAA state to lose three notches in a matter on months.
Mr Bhatia said Britain will be deemed to have lost its reserve currency status – for the first time since the early 18th Century – if the share of sterling bonds in global central bank portfolios falls below 3pc, with a knock-on effect on the rating. It was 4.9pc at the end of last year.
“To be a reserve currency means that the world has trust in you and is happy to hold its savings in your currency. It creates a pool of available capital. If you lose this and sterling becomes just another currency, a key advantage is lost” he said.
The Office for Budget Responsibility originally expected the budget deficit to fall to 2.9pc of GDP this year but has gone back to the drawing board since Brexit. It is also launching a new “fiscal risks” report as part of a revamped charter.
The OBR now expects a radically different trajectory as weaker growth eats into future tax revenue.
If the Government goes ahead with a major spending boost on infrastructure schemes this could push the deficit back above 4pc of GDP, a level that might start to raise eyebrows given that we are at the top of the economic cycle.
This would imply a jump back towards double-digit deficits in a recession. Public debt is already 90pc of GDP, though it has been far higher at different times over the last two centuries.
There is no sign of a ‘Gilts strike yet. Yields on 10-year UK debt have nudged up to 0.98pc on inflation expectations but are still lower than for comparable US Treasuries. The real test may come later once the Bank of England completes it latest round of bond purchases, worth £50bn. The Bank is in effect capping the yields artificially.
Mr Bhatia said Theresa May has proved to be a “relatively safe pair of hands” as Prime Minister but the Brexit vote has an inexorable logic of its own. The worry is that a hard outcome could set off capital outflows and expose the Achilles Heel of the UK financial system.
S&P said the level of short-term external debt coming due over the next 12 months is over 800pc of current account receipts, the highest of 131 countries that it rates. The figure is less than 320pc for France and the US.
Much of this short-term debt reflects the activities of banks operating in the City, many of them large foreign institutions. The liabilities and assets mostly ‘net out’.
The immediate devaluation shock in June did not expose any serious mismatches in currencies or maturities but the concerns linger. Capital flight could take on a life of its own. “Things seem to be adjusting, partially due to the exchange rate, but the biggest issue is the absolute size of the external financing requirement,” he said.
Britain has been running a current account deficit for years, settling at 5.9pc of GDP in the second quarter. This gap is funded by continuous inflows of foreign capital, leaving the country dependent on the kindness of strangers – or to put it more bluntly, at the mercy of very fickle foreign funds.
Tags: Brexit, Brexit hardens, European Union, hardening of attitudes, raise the deficit, S&P, Standard & Poor's, Standard & Poor’s stripped Britain of its AAA status immediately after the Brexit vote, Theresa May, UK reserve currency status