Do the Bond Rating Agencies Think Brexit Will Cause the UK to Forget How to Print Money?

June 28, 2016

CEPR

This is a serious question. BBC told readers that Fitch and Moody’s both lowered their outlooks for debt issued by the British government following the Brexit vote. The question is, what do these bond-rating agencies mean when they lower the rating of a country that issues debt denominated in a currency it prints.

This issue came up back in 2011 when S&P downgraded the debt of the United States following a long standoff on a budget agreement between President Obama and the Republican Congress. While U.S. debt is also denominated in a currency we print, there was at least a not 100 percent absurd story where another standoff could lead to the government not paying its debt. (It’s only 99.99999999 percent absurd.)

But in the UK there is no possible issue of a division of power blocking normal debt payments since the country has a parliamentary government. So what are the bond rating agencies telling us when they lower its debt rating? For private companies or governments that issue debt in a currency they do not issue, the meaning is clear. There is a possibility they won’t have enough money to pay their debts. In the case of companies, this means a risk of bankruptcy. In the case of governments that can’t go bankrupt, there is still a risk of a write-down in which creditors will have to accept less than full payment on their bonds.

But the UK will always be able to print the pounds needed to pay the bonds it has issued. So what are the credit rating agencies saying when they downgrade them. This could be seen as an inflation risk projection, except the rating agencies don’t have special expertise in inflation projections and furthermore have not historically tied their ratings to inflation. For example, they did not downgrade the debt of the United States and other countries in the seventies even as inflation increased to double-digit rates. (FWIW, inflation in the UK has been close to zero in the last year.)

So what do the bond-rating agencies think they are telling us about the UK? Inquiring minds want to know.