Pound Falls to 16-Month Low Versus Euro After Moody’s Downgrade

Bloomberg: The pound fell to its weakest level in almost 16 months against the euro after Moody’s Investors Service cut the U.K.’s AAA credit rating, citing weakness in the nation’s growth outlook.

U.K. government bonds pared an earlier decline. Moody’s lowered Britain’s rating by one level to Aa1 from Aaa on Feb. 22. Sterling, which has tumbled 6.8 percent against the dollar this year, dropped to the lowest since July 2010 before a government report this week that analysts said will show Britain’s economy shrank last quarter.

“Although the timing of the downgrade was a surprise, overall the market has been anticipating a ratings change,” said Ian Stannard, head of European foreign-exchange strategy at Morgan Stanley in London. “In recent weeks we have seen sterling’s safe-haven status erode. After the initial knee-jerk reaction there is the potential for a rebound.”

The pound slid 0.7 percent to 87.59 pence per euro as of 11:27 a.m. London time after depreciating to 87.75 pence, the weakest since Oct. 31, 2011. The pound was little changed at $1.5149 after declining to $1.5073, the lowest since July 2010.

Sterling has slumped 6 percent this year, the second-worst performer among 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes. Only the yen has fallen more, losing 6.7 percent. The dollar strengthened 1.7 percent.

Switch Emphasis

Three-month implied volatility on the pound versus the euro climbed as high as 9.4 percent, the most since May. 18. Volatility on the pound versus the dollar climbed to 9.23 percent, the highest since June. 19.

The premium for three-month options granting right to buy the euro against the pound relative to those allowing for sales rose to as high as 0.415 percentage point, the most since May 4, 2011.

U.K. Chancellor of the Exchequer George Osborne said the government should “stick to its course” to reduce Britain’s debt after the downgrade, while the opposition Labour Party called on him to switch his emphasis from cutting the deficit to spurring growth.

Osborne was backed by former Conservative Chancellor Ken Clarke and Business Secretary Vince Cable, who downplayed the significance of the Moody’s announcement. Investors also often ignore such actions, evidenced by the drop in French 10-year bond yields following a downgrade last year and a rally in Treasuries after the U.S. lost its AAA rating at Standard and Poor’s in 2011.

Short-Lived

“With so many other advanced economies having already been downgraded by at least one ratings agency, we do not expect a major market fallout from the decision,” Goldman Sachs Group Inc. economists Kevin Daly and Sebastian Graves wrote in a note published Feb. 23. “The experience of the U.S. also suggests that any impact will be reasonably short-lived.”

The yield on the benchmark 10-year gilt rose two basis points to 2.13 percent after climbing as much as six basis points to 2.17 percent. The price of the 1.75 percent bond maturing in September 2022 fell 0.13, or 1.30 pounds per 1,000- pound face amount, to 96.785.

Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook last year, according to data compiled by Bloomberg published in December.

U.K. government bonds lost 2.1 percent this year through Feb. 22, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German debt dropped 1.2 percent and Treasuries declined 0.7 percent.

Asset Purchases

The pound fell last week and gilts advanced after Bank of England minutes showed GovernorMervyn King, along with Paul Fisher and David Miles, voted to raise the central bank’s asset- purchase target at the Feb. 7 meeting by 25 billion pounds to 400 billion pounds. Economists had predicted only one of the central bank’s nine policy makers would vote for more quantitative easing.

While the U.K. faces further downgrades, such a move would be unlikely to cause investors to sell gilts, according to Pacific Investment Management Co.’s Michael Amey.

“I wouldn’t be at all surprised if we get a second downgrade and if it comes reasonably soon,” Amey said in an interview on Bloomberg Television’s “The Pulse” with Francine Lacqua. “I’d be surprised if there’s a lot of forced selling on a further move.”

Amey also said the Bank of England is likely to resume purchases of government bonds, probably starting with a 25 billion-pound increase in its Asset Purchase Facility.

BNP Paribas SA raised its forecast for the central bank to increase its bond-buying target by 100 billion pounds, starting from its August meeting, David Tinsley, chief U.K. economist at in London, wrote in client note today.

The U.K. economy contracted 0.3 percent in the three months through December 2012, matching the preliminary estimate released Jan. 25, according to the median of 35 forecasts in a Bloomberg News Survey. The Office for National Statistics will release the data on Feb. 27.

reporters on this story: David Goodman in London