THE Friday night drop was the old custom of PR men placing news stories in the grateful arms of Sunday newspaper financial editors. In return for an exclusive, they could usually guarantee a good press. Even the best PR man, however, would find it hard to spin Moody's decision to downgrade Britain from AAA to AA1, announced just before 10pm on a Friday night. A lot of people thought the downgrade would happen at some point this year. Although the government had a bigger-than-expected surplus in January, it may well end up with a bigger deficit in 2012-13 than it did in 2011-12. The big spending cuts have yet to come. Austerity is planned not just for this Parliament but for the next. The economy is stuck in the doldrums, although at least unemployment has been falling. Moody's gives three reasons for the change

1, The continuing weakness in the UK's medium-term growth outlook, with a period of sluggish growth which Moody's now expects will extend into the second half of the decade; 2. The challenges that subdued medium-term growth prospects pose to the government's fiscal consolidation programme, which will now extend well into the next parliament; 3. And, as a consequence of the UK's high and rising debt burden, a deterioration in the shock-absorption capacity of the government's balance sheet, which is unlikely to reverse before 2016.

In Britain, the initial discussion of the downgrade has been largely political; it does not look good for a government that has staked its reputation on reducing the deficit as a way of reassuring the markets and avoiding the fate of Greece. Ed Balls, the combative Labour spokesman described it as a "humiliating blow" for the chancellor. The UK now has a lower rating from Moody's than Luxembourg and the Isle Of Man. There are 15 AAA-rated countries left; Moody's, unlike S&P, still gives the US top rating.

Will the markets take fright? They did not blink when the US was downgraded by S&P in 2011. Often the ratings agencies are one step behind the markets. (To be fair, they have to take a lot of flak over rating changes, so have to proceed in a cautious, methodical way.)

But the downgrade has come at an awkward time when the pound is already under pressure. Mansoor Mohi-Uddin of UBS writes that

The pound, like the yen recently, is undergoing a sharp devaluation against the other major currencies. Late on Friday, Moody's stripped the UK of its AAA rating citing continued weakness in Britain's medium term growth outlook. We remain bearish sterling and expect Cable to trade in a lower 1.40-1.50 range over the next couple of months.

The UK benefited in 2011 and 2012 from its apparent safe haven status, relative to the euro zone. Gilt yields fell to all-time lows. Ten year yields are now back over 2% and 30-year yields are 20 basis points higher than a month ago, at 3.38%. For foreign investors, those yields are hardly high enough to compensate them for holding a currency that has fallen 7% since the start of the year. Nor do yields look that great to a domestic investor, given that the Bank of England has missed the 2% inflation target for 38 months and expects to miss it again for the next 2 years (not so much a target as a vague aspiration). Pension funds must buy gilts to match their liabilities. But unlike US Treasuries, the most liquid market in the world and a key component of forex reserves the world over, no one outside the UK has to own gilts.

Three members of the monetary policy committee were considering more gilt buying at the latest meeting; the Bank may find itself the most eager buyer in a reluctant market.

(Picture credit: AFP)