Does the UK risk losing its triple-A rating?

Does the UK risk losing its triple-A rating?

Good morning and welcome to today’s foreign exchange market commentary on Thursday, the 13th of September.

The European crisis hasn’t done much good to the British economy. Exports have taken a hit while business confidence has plummeted. To make matters worse, faith in the banking system has taken been badly shaken that was already reeling under credibility deficit.

But Europe’s crisis had at least one positive effect. Britain largely escaped close international scrutiny. But that may change soon.

As deficits rise and growth stalls, borrowings can only go higher. Under such circumstances, it’s only a matter of time before one of the credit rating agencies pull the triple-A plug on Britain. The country may still slip back into full-scale recession. The Olympics driven boom has long ended and tourism revenue no longer seems attractive. Exports are stuck despite sterling depreciating significantly this year. When the downgrade happens, the pound and the FTSE 100 will be the immediate casualty.

The country borrowed GBP 600 million in July as tax collection shrank 0.8 percent. Surprising since July has traditionally been a strong month for revenues. Between April and July, the govt. borrowed a massive GBP 44.9 billion, nearly 20 percent higher over the same period last year. The govt. nonetheless remains committed to bring down deficits! (or so it claims). The Centre for Policy Studies estimates debt (as a percentage of GDP) to rise to 76 percent in 2014-15 from 53 percent in 2009-10.

Rising debt in the absence of structural reforms is a perfect recipe for disaster. The Spanish and the Italians know best. A state that consumes half of the GDP and has open-ended liabilities in welfare, pensions and healthcare doesn’t really inspire confidence. Add to this stricken banks that are a huge potential liability. Under-water mortgages can wipe out significant amount of assets in a matter of days.

Markets may choose to ignore a ratings cut for a politically stable country. The British coalition, however, fails on this count and is unlikely to survive the aftermath of a ratings cut. That should keep investors awake at night.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2466
GBP/US$ – 1.6101
GBP/CHF – 1.5088
GBP/CAN$ – 1.5738
GBP/AUS$ – 1.5421
GBP/ZAR – 13.4951
GBP/JPY – 125.16
GBP/HKD – 12.4831
GBP/NZD – 1.9632
GBP/SEK – 10.5810

EUR: The single-currency gained traction across the board following the German Constitutional Court’s refusal to block the ESM. The court however attached conditions to the ruling, limiting Germany’s liability to EUR 190 billion. Also the centre-right Liberals’ return to power in the Netherlands provided further support to the common currency as the euro-skeptic parties were left well behind in the final count. The EUR/USD pair is now trading comfortably above the 1.2900 level and opened at 1.2915 this morning. The FX market is expected to remained cautious ahead of the US FOMC statement later tonight and unlikely to witness much volatility due to lack of tier-1 economic news from Europe. The euro has strengthened against the pound as well and the GBP/EUR pair opens at 1.2470 this morning.

USD: The greenback continued to trade lower against the euro and sterling as risk sentiments improved following the German high court decision yesterday. Spanish and Italian 10-year borrowing costs slipped further while credit default swap spreads continue to tighten across peripheral Europe. The greenback may come under further selling pressure today if the Fed announces further easing. Today’s an extremely busy day on the other side of the Atlantic with inflation and unemployment data coming in along with the all-important FOMC decision. The GBP/USD is trading higher in anticipation and opens at 1.6110 this morning.

Have a great day!

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