Last updated: May 21, 2009 3:55 pm

Sterling

Well, it was nice while it lasted. The pound has had a good run this year. Since December’s trough, sterling’s trade-weighted exchange rate has risen 9 per cent – a big move and one due a correction, or at least a pause. A review of Britain’s credit rating provided the excuse on Thursday. Sterling tumbled and gilts fell after Standard & Poor’s cut the UK’s debt outlook to negative, warning that the country’s ratio of debt to GDP could soon double to 100 per cent and then stay there.

There is, though, little new about such calculations. Sure, new data showed that government borrowing almost quintupled to £8.5bn in April compared with the same month the year before while tax receipts fell almost 10 per cent. But a high debt/GDP ratio need not be disastrous, as economic historians often point out. After all, British national debt was that high after the second world war, even if it was a period of austerity for those who lived through it. Sugar rationing was lifted only in 1953 and, to save foreign exchange, bananas were a rarity.

What does matter is how long UK debt continues to rise. For now, gilt spreads over German Bunds remain tighter than for any other big European economy. But at some point markets will demand compensation for the growing credit risk. The government to be formed after elections that are due at the latest in the middle of next year, therefore, needs to slow growth in the national debt and then reverse it. This will be a painful and unpopular task, as squabbling over the public purse always is. It is probably no accident that the governments of other European countries that have debt to GDP ratios of about 100 per cent, such as Italy, Greece and Belgium, are characterised by fractious, fragile and fleeting coalitions.

 

BACKGROUND NEWS

 

Sterling was hit on Thursday after the outlook for the UK economy was thrown into doubt when the country’s sovereign debt ratings were revised from stable to negative by Standard & Poor’s.

The downgrade is highly embarrassing for the Treasury and will give ammunition to the opposition Conservative party, which argues the government is presiding over a growing and unstable mountain of debt. Sterling fell 1.2 per cent against the dollar and 1.4 per cent against the euro at one point before recovering. UK shares and bonds also recovered after falling sharply on the S&P announcement.

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