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What does a credit rating downgrade mean for UK finances?

Published 25/06/2016

The financial shockwaves of the Brexit vote have begun to reverberate as the outlook on Britain's credit rating was downgraded
The financial shockwaves of the Brexit vote have begun to reverberate as the outlook on Britain's credit rating was downgraded

The financial shockwaves of the Brexit vote have begun to reverberate as the outlook on Britain's credit rating was downgraded to "negative".

Ratings agency Moody's changed the UK's long-term issuer and debt ratings to negative from stable due to uncertainty after the vote to leave the European Union.

Another leading agency, Standard and Poor's (S&P), also warned that Britain could lose its AAA rating following the referendum result.

Moody's and another ratings agency, Fitch, had already stripped Britain of its AAA rating before the referendum.

Here is what it means:

:: What is the UK's current financial situation?

The UK Government has one of the largest budget deficits of any advanced economy, with public sector net debt excluding banks reaching £1,606.9 billion, according to the Office for National Statistics (ONS). That debt is equivalent to 83.7% of the UK's economic output, known as gross domestic product (GDP).

The ONS said the Chancellor borrowed £74.9 billion for the financial year ending in March, overshooting the annual target by £2.7 billion.

It was a setback for George Osborne in his efforts to shore up the nation's finances after he pledged to return the UK to a surplus by 2020.

:: What are the ratings agencies worried about?

The ratings agencies are concerned Brexit will make this plan harder to achieve, particularly as they predict economic growth will be stunted and uncertainty over trade arrangements will be prolonged while Britain negotiates to leave the EU.

Moody's also said it did not believe the negative effects of Brexit on the UK economy would be met by the savings the country would make from no longer having to contribute to the EU budget.

:: Why is a credit rating so important?

Borrowing funds are raised through gilt markets - the sale of Government-guaranteed debt.

A rating lower than AAA means this debt will be seen as a riskier investment and investors will want a higher rate of return for their cash - which could eventually force UK interest rates up.

As well as the cost of raising debt, it may also be more difficult to sell it. Some major international buyers of debt are only allowed to hold AAA-rated bonds, meaning they would not be able to buy Government debt if it was downgraded to the next level down, AA+.

:: How do ratings work?

Ratings indicate the relative likelihood that a country or business will default on its debt.

AAA is the highest rating - not just for the debt of countries but also companies. Ratings from AAA through to BBB are known as ''investment grade'' but below that, bonds are ''speculative'' or ''junk''.

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