A reality check from Standard & Poor’s

May 21, 2009

REUTERS– Neil Collins is a Reuters columnist. The views expressed are his own –

Standard & Poor’s could have chosen a better day to kick the British economy, by placing the UK onto “negative outlook”, the usual precursor to a downgrade of S&P’s rating of an issuer’s debt.

The move came minutes before the Debt Management Office closed its massive auction of 5 billion pounds of 2014 stock, and minutes after the release of figures showing the Public Sector Net Borrowing Requirement leaping to 8.5 billion pounds in April, a sum which not long ago would have been considered high for a whole year.

Economist Howard Archer at Global Insight immediately called the figure “dire, starting the new fiscal year off as it is highly likely to continue.”

S&P, meanwhile, now fears that the net general government debt burden “could approach 100 percent of GDP and remain near that level in the medium term.”

It’s hard to describe the UK public finances as anything other than a disaster area. The forecasts made in last month’s Budget looked optimistic within days, and even these require the DMO to borrow 220 billion pounds this financial year, or almost a billion pounds every working day.

Yet while the DMO soaks up cash, the Bank of England is desperately creating it. Its “quantitative easing” programme has been in full swing this week, buying in 1.326 billion pounds of a stock which looks very like the one that the DMO was issuing just one day later.

The experts will tell you that because the life of the new stock is not quite five years, it falls outside the Bank’s five to 25-year target zone for QE, and is therefore qualitatively different. This is pure mumbo-jumbo. Essentially what is happening is one arm of the government is creating money for another arm of the government to borrow.

The traders can hardly believe their luck, selling expensively to the Bank and buying cheaply from the DMO.

This waste of taxpayers’ money would be bad enough, but the real damage is the false sense of security this round-tripping produces. Britain is in real danger of falling into a debt trap, where the cost of borrowing spirals up with the amount the government has to raise.

As the rating agency’s reality check concludes: “A government debt burden [of nearly 100 percent of GDP] if sustained, would in S&P’s view be incompatible with an AAA rating.”

Loss of that rating would lead to a higher cost of government borrowing, damaging the chances of avoiding the trap.

Were the Labour administration not in total funk, it might seize on this report to admit that its spending plans are not sustainable. Capital projects, like the NHS IT scheme, ID cards, Crossrail, aircraft carriers, the Eurofighter and much else will have to go, and the next government will have to impose real cuts in the core spending of education, health and welfare.

S&P’s warning shot shows that the phony war is over, and the real pain lies ahead.


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