Britain Keeps Moody's AAA Rating Thanks to Austerity Moves

The government of British Prime Minister David Cameron won a key vote of confidence from the financial community Monday when Moody's Investors Services (MCO) announced that it would continue to apply a AAA rating to the country's debt, despite its severe economic dislocation.

Kenneth Orchard, Moody's lead analyst for the U.K., said in an annual report that the financial crisis caused "serious long-term damage" to the country's economy.

"The country's economic outlook is also more challenging because private sector deleveraging, the uncertain state of the financial sector and slower growth in the U.K.'s main trading partners are not conducive to allowing GDP growth to return to its pre-crisis trend rate," Orchard said in a statement. "Nevertheless, Moody's believes that the U.K. has the wherewithal and ability to meet these challenges whilst maintaining its AAA-rating."

Cameron's government has adopted a severe austerity plan that includes spending cuts of about $145 billion over five years. It is also boosting capital gains taxes and its national "value-added" sales tax by $44 billion.

According to the Organization of Economic Co-operation ad Development, Britain's growth is actually outpacing other countries in Europe, with GDP growth in the third quarter expected to hit 2.7%, compared with 0.7 in both Germany and France.

U.K.'s Problems Resemble Those of U.S. . . .

Tom Kirchmaier, a visiting fellow at the London School of Economics, says that, as in the United States, British households ran up too much debt in the early part of the last decade, primarily to buy houses during a housing bubble.

"Those that have taken on too much debt have to pay it down now, and that clearly means they have to lower their consumption," Kirchmaier says.

With both the private sector and the government spending less, GDP growth will be negatively impacted, he says. In addition, Britain's main trading partners in Europe are also cutting back on their government expenditures, which will mean less demand for British goods.

Kirchmaier says the British government has decided to run the risk of a short-term recession in order to preserve its excellent credit rating and its standing within the financial markets.

"The government clearly said it wants to be on the safe side and save a lot of money," Kirchmaier says.

. . . But British Safety Net Makes Solution More Tolerable

Kirchmaier adds that he is among the growing number of economists who believe that Britain may suffer a double-dip recession, but in his opinion, such an outcome will be less drastic in a place like the U.K. than it would in the United States.

"In Britain you have a lot of automatic stabilizers, which means that if you become unemployed in Britain, you fall into the public safety net," Kirchmaier says. "It will never have the strong negative effect it would have in the U.S., so you can brake public finances harder here because if people become unemployed here, they don't stop consuming."

Moody's says its outlook for the country is stable, implying that the AAA rating will not change at any time in the foreseeable future. It said government debt is well-structured, meaning that it is mostly very long term bonds that can't be rolled over at lower interest rates, thus limiting re-financing risk because the current interest rate is much lower than when most of the debt was issued.

Kirchmaier says the public seems to be behind Cameron even though his rule has meant much less money available for public spending.

"At the moment, there is quite wide public support for the austerity program, but let's see what will happen once people really start to feel the pain, which they have not yet," he says.

The U.K. adopted its austerity plan in June 2010, cutting the budgets of most ministries by 25%.