What’s the politics if the UK lost its AAA credit rating?

While the Lockerbie release story has been dominating the news a more bread and butter issue has received scant coverage yet has the potential to have an even bigger impact on the election campaign.

The government’s borrowing figures for July were much worse than expected – and needless to say, expectations weren’t healthy to start with. The scale of the battering that the public finances have taken in the recession is unprecedented in peacetime and is putting strain on Britain’s top-ranked AAA credit rating.

In May, the credit rating agency Standard & Poor’s put the UK on ‘negative watch’ indicating that a future downgrade was a reasonable possibility. The further decline in the state of the public finances will have brought that possibility even more into play.

To put it into context, the government’s budget forecast was for it to put at least £3,000 on the nation’s credit card for every man, woman and child in the country this year, and similar amounts next year and the year after. That number may well now be low. In three years’ time, a family of four will in effect owe the money markets getting on for £40,000 more than they did before the credit crunch. Admittedly, that’s a simplistic analysis but not a wholly inaccurate one.

Were the UK to be downgraded, it would not be the end of the world by any means. Many countries have lesser ratings, including some very large and advanced economies, Japan being the most obvious (and for the same reason – the level of public debt is very high). Even so, the symbolic impact might be of more import than the economic one in terms of how it plays politically.

Britain has always enjoyed the top credit rating available and were the country to lose that centuries-old standing there would be a degree of humiliation that went with it, which could affect perceptions of Labour for a generation

It would surely also make any election campaign Labour might have been planning based on ‘Tory cuts’ less plausible as while those cuts would surely come, the public would be less likely to believe that Labour could stave them off either or that if they could, the price in taxes would be heavy. By the same token, the rather less likely (and less dramatic) removal of the negative outlook for Britain’s rating would bolster the government’s claims as to their handling of the crisis.

As yet, a downgrade is not an imminent prospect. Only one agency has issued a negative outlook and the election due within the next year means there’s enough political uncertainty to hold off medium-term judgements. That said, there are still the autumn statement and 2010 budget to come and one or both could change the agencies’ minds, elections notwithstanding. Likewise, a few more months of deficits being so much over projections could result in the same event.

I’m not an economist but my guess is that the chances of at least one agency issuing a downgrade before the election are odds-against but not heavily so and were it to happen, who knows how long it would hurt Brown’s party?

David Herdson