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Forex Flash: GBP/USD down in kneejerk reaction - BTMU

Lee Hardman, FX analyst at the Bank of Tokyo Mitsubishi UFJ notes that the Pound has weakened initially in a knee-jerk fashion following the announcement from Moody’s late on Friday that it had decided to downgrade the UK’s sovereign debt rating by one notch to Aa1 from Aaa.

He adds that the rating outlook is now stablea and Moody’s decision was driven by: i) continuing weakness in the UK’s medium-term growth outlook, ii) which poses challenges to the government’s fiscal consolidation programme with UK gross government debt now seen peaking at just over 96% of GDP in 2016, and iii) the UK’s high and rising debt burden has impaired it’s ability to contain and quickly reverse the impact of adverse economic or financial shocks.

Hardman continues to note that Moody’s decision was not particularly surprising following fiscal slippage evident in last year’s Autumn Statement. However, he feels that it was somewhat surprising that Moody’s didn’t wait until after the upcoming Budget on the 20th March. The impact of the ratings downgrade upon the gilt market is likely to be modest similar to when the US and France recently lost their AAA ratings.

He writes, “The main impact of the downgrade is that it is politically damaging for the UK coalition government who pledged to maintain the UK’s AAA rating through more aggressive fiscal tightening. Chancellor Osborne stated immediately after the downgrade announcement that he would “redouble” his commitment to the government’s current plan A.”

Hardman feels that with fiscal policy set to remain tight, the burden to stimulate growth remains upon the BoE through looser monetary policy, and a weak/weaker pound. However weak external demand is short-circuiting potential support from a weak pound and indirectly is resulting in higher inflation which is squeezing real incomes and consumption.

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