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Chill wind blows for triple A nations

Date: Monday, May 25, 2009
Author: David Oakley, Capital Markets Correspondent, FT.com

Rich countries face a threat to their status as the safest places to invest after the UK was warned last week that it could lose its top-notch credit rating.

The triple A club of countries with the highest quality credit ratings has shrunk this year after Spain in January and Ireland in March were downgraded by Standard & Poor’s because of worries over their economies.

Fears have grown that other big economies, such as the US and Germany, could be in danger of downgrades after S&P’s decision to lower the UK’s credit outlook to negative from stable.

John Wraith, head of sterling rates product development at RBC Capital Markets, said: “The world is a different place now. We have seen Spain and Ireland lose their triple A status this year, and the UK could be next if the government doesn’t fundamentally address the underlying situation with increased fiscal rigour.”

S&P’s decision on the UK was based on concerns that government debt could grow to unsustainable levels and have ramifications for the country’s economy.

After Thursday’s announcement of the outlook downgrade, yields on the UK’s benchmark 10-year bond rose 7 basis points.

By Friday prices on 10-year gilts had fallen to their lowest in three months.

However, analysts do not believe that the other triple A nations among the G7 – the US, Canada, Germany and France – are in as great a danger as the UK of losing their triple A status.

Even though the UK has a much lower debt burden than other economies, its public finances are more exposed because of the higher risks that international investors, who hold about 40 per cent of the gilts market, will be forced to sell since many are only allowed to hold triple A debt.

The OECD expects gross government debt in the US to reach 78 per cent of gross domestic product this year compared with 64 per cent in the UK.

However, the US is able to run up much higher debts because it has the luxury of the dollar being a reserve currency.

Luo Ping, of the China Banking Regulatory Commission, has said: “We could happily reduce our gilt holdings, but not US Treasuries. They are the safe haven. For everyone, including China, it is the only option.”

France, expected to run a gross government debt of 76 per cent of GDP in 2009 – much higher than the UK – has the advantage of being in the eurozone.

The euro is a reserve currency, like the dollar, which means many central banks have little choice but to hold euro-denominated assets.