A self-inflicted embarrassment

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The downgrade of the UK’s creditworthiness by Moody’s, the rating agency, to the second-highest notch is less a moment of economic significance than one of acute political embarrassment, and a self-inflicted one at that.

Announcements by credit rating agencies should largely be treated as irrelevant. Moody’s statement reveals nothing that professional investors do not already know. Still, ratings decisions can sometimes have real effects because of the wrong-headed way investment mandates and capital rules are designed to rely on them.

But in this case, the downgrade simply catches up with recent market movements. The UK’s slowdown means that deficits and debt will be higher than expected. Meanwhile the eurozone, while equally sluggish, has opted to stick together. The natural market response has been a reversal in the past flows of haven-seeking funds into sterling and gilts.

While the hallmark of a triple A rating has symbolic significance, George Osborne is guilty of elevating it far out of proportion. He pinned his colours to the rating agencies’ mast by using the preservation of the triple A as a justification for austerity. If the downgrade shatters his credibility with voters, that is an unforced political error.

What it will not do is alter the debate around the government’s fiscal strategy. A large part of the UK’s growth disappointment has come from commodity prices, the global slowdown and an export structure mismatched with new markets. That supports the government’s case that investor confidence would be even worse if it relaxed its deficit-cutting zeal. Those who have called for larger fiscal stimulus have always contended that the Bank of England can keep gilt yields under control and belittled the risk of investor flight. For them, Moody’s opinion should be irrelevant.

None of this changes the fact that the UK needs stronger domestic demand. As this newspaper has long argued, there is room to shift resources from inefficient subsidies to uses that can stimulate the economy, such as infrastructure. Monetary policy must do more. And structural reforms are overdue – to unclog banking and tilt Britain away from over-relying on finance.

This is not 1992. The downgrade does not expose a government’s impotence in the face of market forces the way ejection from the European exchange rate mechanism did. A real loss of market confidence in the UK would look a lot scarier.

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