UK borrowing costs fall despite rating cuts

Long-term rate at lowest level this year

UK long-term borrowing costs have fallen to their lowest level this year, as troubles in the eurozone offset worries over a fresh batch of credit rating downgrades for government-backed institutions.

The downgrades for organisations ranging from Birmingham council to Network Rail followed the one-notch cut to the UK’s triple-A rating by Moody’s last week.

However, the markets appeared more focused on the impasse after the Italian elections and worries about the eurozone.

Gary Jenkins, head of consultancy Swordfish Research, said: “It just goes to show that this story is all about politics for now. The eurozone and Italy is much more of a concern than the UK’s triple-A rating for most investors.”

However, the latest Moody’s downgrades, which also included 26 housing associations, two universities, Transport for London and London Continental Railways – the government-owned former transport funding vehicle – will spark future problems, according to some investors and company treasurers.

They warn that other rating agencies Standard & Poor’s and Fitch are also likely to downgrade the UK’s triple-A status, which will start to push borrowing costs higher and heap pressure on the government.

S&P put the UK on negative outlook in mid-December and Fitch did so in March 2012. Typically, a rating agency waits about 18 months before it cuts from negative outlook, but some investors say Moody’s action will prompt them to move more swiftly.

There is also unease among some UK organisations that have borrowed in the debt markets in recent years, such as housing associations which use the money to develop new homes.

The latest downgrades reflect the dependence of many of the bodies on the financial health of the central government.

Housing associations that suffered rating cuts include some of the biggest names in the sector, such as Circle Anglia, Peabody Trust, Places for People and Family Mosaic.

Moody’s also cut Birmingham, Cornwall, Guildford and Wandsworth councils from triple A to Aa1 and Lancashire from Aa1 to Aa2. However, most council borrowing comes through the Public Works Loan Board, a government agency, and is therefore unaffected by credit ratings.

Network Rail, the train operator, and Transport for London, which funds Tube capital expenditure in the capital, were both sanguine about the rating cut. The bonds of both groups enjoyed a fall in yields in line with the drop in government bonds, which on Tuesday closed at 1.96 per cent for 10 year debt, the lowest since December.

Overall, investors stressed the UK still has a relatively strong economy. Unlike Greece, which suffered a spate of forced sales among investors who were not allowed to hold junk bonds when it was downgraded below investment grade status, a one-notch cut from triple A is unlikely to upset investment flows into UK government bonds.

Indeed, the Investment Management Association, which represents UK fund managers, changed guidelines on retail gilt portfolios this week to allow investors to continue buying bonds no longer rated triple A.

“The IMA’s move shows that a rating doesn’t always matter,” said one investor. “If the eurozone continues to trouble investors, gilts will benefit from the flight to safety. Problems may arise if sentiment in the eurozone improves.”

Additional reporting by Mark Odell, Ed Hammond and Jim Pickard

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