Moody's Lowers Outlook on UK, France; Downgrades Italy, Spain, Portugal; EUR/USD Hit

EUR/USD - freestockcharts.com
I know European sovereign debt downgrades are pretty much priced in, but today Moody's downgraded and lowered its outlook on a few European nations. It downgraded Italy to A3 from A2, Malta to A3 from A2, Portugal to Ba3 from Ba2, Slovakia to A2 from A1, Slovenia to A2 from A1, and Spain to A3 from A1 (two notches). All have negative outlooks. Moody's also lowered its outlook on France, Austria and the United Kingdom to negative. All are rated Aaa, which is the highest credit rating.

EUR/USD is trading lower at 1.31533, and is close to testing 10/4/2011 support again at 1.31460. The 50DMA is at 1.2998 on the chart. Since the UK is not really in the spotlight at the moment, here is the reasoning behind Moody's negative outlook.

"RATIONALE FOR NEGATIVE OUTLOOK

The primary driver underlying Moody's decision to change the outlook on the UK's Aaa rating to negative is the weaker macroeconomic environment, which will challenge the government's efforts to place its debt burden on a downward trajectory over the coming years. These challenges, reflecting the combined effect of a commodity price driven hit to real incomes, the confidence shock from the euro area and a reassessment of the lasting effects of the financial crisis on potential output, were already evident in the government's Autumn Statement. The statement announced that a further two years of austerity measures would be needed in order for the government to meet its fiscal mandate of achieving a cyclically adjusted current budget balance by the end of a rolling five-year time horizon, and to reach its target of placing net public sector debt on a declining path by fiscal year 2015-16.

Moody's central expectation is that these objectives will be met, with a general government gross debt-to-GDP ratio peaking at just under 95% in 2014 or 2015, before gradually declining thereafter. However, Moody's expects the UK's debt to peak later, and at a higher level, than in most other Aaa-rated countries. Moreover, risks to the rating agency's forecasts are skewed to the downside. In part, these risks are the by-product of a necessary fiscal consolidation programme and the ongoing parallel deleveraging process in both the household and financial sectors. Moody's also believes that the further cutbacks announced last autumn indicate that the government has a reduced capacity to absorb further abrupt economic or fiscal deterioration without incurring a further slippage in its consolidation timetable.

A combination of a rising medium-term debt trajectory and lower-than-expected trend economic growth would put into question the government's ability to retain its Aaa rating. The UK's outstanding debt places it amongst the most heavily indebted of its Aaa-rated peers, alongside the United States and France whose Aaa ratings also carry a negative outlook.

The second and interrelated driver of Moody's decision to change the UK's rating outlook to negative is the fact that the weaker environment is also, in part, a by-product of the ongoing crisis in the euro area. Although the UK is outside the euro area, the crisis is affecting the UK through three channels: trade, the financial sector and consumer and investor confidence.

Moody's believes that there is considerable uncertainty over the euro area's prospects for institutional reform of its fiscal and economic framework and over the resources that will be made available to deal with the crisis. Moreover, Europe's weak macroeconomic outlook complicates the implementation of domestic austerity programmes and the structural reforms that are needed to promote competitiveness. Moody's believes that these factors will continue to weigh on market confidence, which is likely to remain fragile, with a high potential for further shocks to funding conditions.

In addition to constraining the creditworthiness of all European sovereigns, the fragile financial environment increases the UK's susceptibility to financial and macroeconomic shocks. Any such shock would pose further risks to the performance of the UK economy and to the strength of its financial sector, with inevitable consequences for the government's ability to achieve fiscal consolidation on schedule. Moreover, while the UK currently enjoys 'safe haven' status, there is also a growing risk that the weaker macroeconomic outlook could damage market confidence in the government's fiscal consolidation programme and cause funding costs to rise."

"WHAT COULD MOVE THE RATING DOWN

The UK's Aaa rating could potentially be downgraded if Moody's were to conclude that debt metrics are unlikely to stabilise within the next 3-4 years, with the deficit, the overall debt burden and/or debt-financing costs continuing on a rising trend. This could happen in one of three scenarios, all of which would imply lower economic and/or government financial strength: (1) a combination of significantly slower economic growth over a multi-year time horizon -- perhaps due to persistent private-sector deleveraging and very weak growth in Europe -- and reduced political commitment to fiscal consolidation, including discretionary fiscal loosening or a failure to respond to a deteriorating fiscal outlook; (2) a sharp rise in debt-refinancing costs, possibly associated with an inflation shock or a deterioration in market confidence over a sustained period; or (3) renewed problems in the banking sector that force a resumption of official support programmes and spill over into the real economy, indirectly causing lower growth and larger budget deficits.

Conversely, the rating outlook could return to stable if the combination of less adverse macroeconomic conditions, progress towards containing the euro area crisis and deficit reduction measures were to ease medium-term uncertainties with regards to the country's debt trajectory." (Source: "Moody’s adjusts ratings of 9 European sovereigns to capture downside risks")

Below is a summary of the downgrades as well. Nothing is really new here. It's the ongoing theme of private and public-sector deleveraging in the West. The ECB's 3-year LTRO helped boost liquidity in the financial system and push European government bond yields lower (prices higher), but there is still a solvency crisis in the eurozone. Is the risk of a large European bank failure (bailout) officially off the table? Now the focus is on whether Greece gets the next €130 billion bailout loan (1, 2, 3) from the EU/IMF to avoid a hard default in March. Portugal's government bond yields and credit default swaps made new highs two weeks ago before pulling back sharply. Greece has a €14.5 billion bond payment due on March 20. The next month will be interesting to watch...

"The main drivers of today's actions are:

- The uncertainty over (i) the euro area's prospects for institutional reform of its fiscal and economic framework and (ii) the resources that will be made available to deal with the crisis.

- Europe's increasingly weak macroeconomic prospects, which threaten the implementation of domestic austerity programmes and the structural reforms that are needed to promote competitiveness.

- The impact that Moody's believes these factors will continue to have on market confidence, which is likely to remain fragile, with a high potential for further shocks to funding conditions for stressed sovereigns and banks.

To a varying degree, these factors are constraining the creditworthiness of all European sovereigns and exacerbating the susceptibility of a number of sovereigns to particular financial and macroeconomic exposures.

Moody's has reflected these constraints and exposures in its decision to downgrade the government bond ratings of Italy, Malta, Portugal, Slovakia, Slovenia and Spain as listed above. The outlook on the ratings of these countries remains negative given the continuing uncertainty over financing conditions over the next few quarters and its corresponding impact on creditworthiness.

In addition, these constraints have also prompted Moody's to change to negative the outlooks on the Aaa ratings of Austria, France and the United Kingdom. The negative outlooks reflect the presence of a number of specific credit pressures that would exacerbate the susceptibility of these sovereigns' balance sheets, and of their ongoing austerity programmes, to any further deterioration in European economic conditions and financial landscape.

An important factor limiting the magnitude of Moody's rating adjustments is the European authorities' commitment to preserving the monetary union and implementing whatever reforms are needed to restore market confidence. These rating actions therefore take into account the steps taken by euro area policymakers in agreeing to a framework to improve fiscal planning and control and measures adopted to stem the risk of contagion."
(Source: "Moody’s adjusts ratings of 9 European sovereigns to capture downside risks")

Related Posts

Comments

HTML Comment Box is loading comments...