George Osborne is adamant that Britain 'cannot waver' over deficit reduction plan
Chancellor George Osborne said the shock warning of a downgrade of the UK credit rating by Moody's demonstrated that the government "cannot waver" from its deficit reduction course – as the governor of the Bank of England, Sir Mervyn King, warned that monetary policy has reached the limits of what it can do to promote growth.
Osborne traded blows with Ed Balls, the shadow chancellor, who claimed that the threatened downgrade of the UK's AAA status, announced late on Monday night, should be a significant warning that the government is on course for disaster.
But the statement from Moody's was worded in a way that allowed Osborne to argue that it was a reflection of the crisis in the eurozone, rather than an attack on Treasury policy.
In words seized on by the Treasury, Moody's added: "The UK's AAA rating could potentially be downgraded if … [there was] reduced political commitment to fiscal consolidation, including discretionary fiscal loosening". The UK was one of six countries the credit rating agency either downgraded or put on negative watch. The warning is unlikely to have any impact on UK interest rates.
The chancellor described the shift as "proof that, in the current global situation, Britain cannot waver from dealing with its debts". He described the announcement as a wake-up call for those pressing for stimulus on the Labour benches.
But the Moody's announcement, alongside the warning from the governor, puts further pressure on Osborne to find policies to boost growth in the March budget.
In his letter to Osborne setting out why inflation was, although falling, still above target, King argued: "The unwelcome combination of sluggish growth and high inflation over the past two years is a reflection of the need for the economy to rebalance following the financial crisis. The process of rebalancing still has a long way to go. Growth remains weak and unemployment is high. While the Monetary Policy Committee can use bank rate or asset purchases to help ease the transition, there is a limit to what monetary policy can achieve when real adjustments are required."
Moody's downgraded Italy, Spain, Portugal, Malta, Slovakia and Slovenia, and put Britain, France and Austria on negative watch, warning that they may be stripped of their AAA ratings, citing Europe's debt crisis. It suggested that any further abrupt economic or fiscal deterioration would put into question the UK government's ability to reduce the debt burden.
In addition, it warned that budget cuts announced in November have reduced the scope for further action, making it harder for the government to meet its goal of eliminating the structural deficit by 2017, the current goal of Osborne's policy.
Conservative MP Matthew Hancock said Moody's decision showed how dangerous it would have been if the Treasury had adopted Labour's economic strategy.
But Balls said he would not set policies by credit rating agencies, claiming they were responsible for imposing such heavy austerity across Europe. He described credit rating agencies as "a weathervane for the way the wind is blowing and the fact is the wind is blowing now in a difficult direction for Britain because, as the report says, we don't have growth in our economy. And let's just remember, when we came off negative outlook in October of 2010, George Osborne said that was a vote of confidence. Now we are going back on to negative outlook, he still wants to say that is a vote of confidence.
Yes, deficits need to be cut, Balls said. "That means tough decisions, but unless you've got growth, if your plan is unbalanced, it becomes self-defeating, and today is the first evidence that even the ratings agencies are waking up to the fact that George Osborne's plan's not working."
The former chancellor Alistair Darling urged the government to take heed, saying: "The economy is 100 miles away from where they thought it was going to be when they came in.
"As it turns out, the present government is actually going to reduce borrowing at the same time that we were going to do it. So their plans aren't a million miles away now from where we would have ended up. And they are actually borrowing £150bn more than they expected to borrow – more than I expected to borrow."
In another sign of the pressure on the government to look at its growth strategy, the British Chambers of Commerce called on Osborne to take a more interventionist role in the budget, adding that he had room for manoeuvre.
BCC chief economist David Kern said: "Since the fiscal mandate relates to 'the cyclically adjusted, or structural, current balance' and not to the total deficit, the chancellor can now consider spending measures that would not affect either the current budget or the structural deficit. This could mean more infrastructure investment, temporary reductions in the cost of employing people, or temporary increases in capital allowances."
Britain is still enjoying near record low borrowing costs. The reason is that investors still view its bonds as a relative safe haven in the global debt storm despite a deficit worse than that of France, which saw its AAA rating downgraded by Standard & Poor's at the end of last year.
"The agencies are not telling us anything new and the subject of downgrades now seems to have become a political football to be knocked back and forth," said David Jones, chief market strategist at IG Index.