Standard and Poor’s lowers Australia’s AAA rating outlook

S&P cited an uncertain poll result as it put Australia’s prized AAA debt rating on “negative” watch, along with major banks.

Standard & Poor's headquarters in New York. Pic: AFP

The Australian dollar has weakened and the local market has stumbled after Standard & Poor’s became the first ratings agency to place Australia’s prized “AAA” sovereign debt rating on “negative” watch.

S&P said the move signalled a 33 per cent chance the nation’s credit rating would be cut in the next two years.

The agency has also put all four bank majors on credit watch in the wake of the potential downgrade of the national downgrade.

A statement is expected to be issued shortly.

The group changed the national debt outlook from “stable” to “negative” just days after all three major credit ratings agencies reaffirmed the country’s AAA status.

Read S&P’s full statement

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The move places policymakers on notice of a potentially damaging cut to the nation’s credit rating should there be no signs of an improvement in the fiscal outlook.

“The negative outlook on Australia reflects our view that without the implementation of more forceful fiscal policy decisions, material government budget deficits may persist for several years with little improvement,” S & P said in a statement.

“Ongoing budget deficits may become incompatible with Australia’s high level of external indebtedness and therefore inconsistent with a “AAA” rating.”

The move follows an uncertain federal election result over the weekend, with S & P listing this as a key reason for the alteration in its outlook today.

“Given the outcome of the July 2 double-dissolution election, in which neither of the traditional governing parties may command a majority in either house, we believe fiscal consolidation may be further postponed,” the ratings agency said.

S & P appeared the closest of the big three agencies to making such a move on Monday as it said the election “decreased visibility” on fiscal policy.

However, the group was already uneasy with the policy picture ahead of the election, with its statement today revealing it lacks the confidence in Treasury and federal government projections for the budget to return to surplus in 2021.

“While we expect that fiscal deficits will improve over the medium term, we are more pessimistic about the central government’s revenue outlook than the government was in its latest budget projections,” S & P said.

Part of the reason for the group’s divergence from government forecasts comes from the projection for iron ore prices to average $US55 a tonne over the next year.

The key Australian export recently recovered to that level as part of a recovery in commodity prices more generally, but S & P contends it could be close to $US20 lower over the next 18 months.

“Aside from commodity prices, we also consider that there remains downside revenue risk if Australia’s inflation and wage growth is weak for longer than the budget anticipates.”

Despite the rising concerns S & P said growth would likely come in at 3 per cent for fiscal 2016 with the assistance of a weaker dollar, while the nation’s banking system was viewed as “one of the strongest globally”.

The ratings agency urged policymakers to press forward with new budget savings measures and pass through those still stuck in the Senate in order to avoid an official ratings cut within the next two years.

“There is a one-in-three chance that we could lower the rating within the next two years if we believe that parliament is unlikely to legislate savings or revenue measures sufficient for the general government sector budget deficit to narrow materially and to be in a balanced position by the early 2020s,” S & P said.

“We will continue to monitor, over the next six to 12 months, the success or otherwise of the new government’s ability to pass revenue and expenditure measures through both houses of parliament.

“We could also lower the rating with any further weakening of Australia’s external position.”

The softening of the external position would be viewed through the lens of current account deficits, terms of trade and the banking sector’s cost of external funding.

The outlook could return to “stable” should additional savings measures be passed or the terms of trade improve significantly.

The development pushed the Australian dollar down as much as US0.6c to US74.67c, but it had recovered to US75.02c at 12.30pm (AEST).

Meanwhile, the benchmark S & P/ASX200 index was trading up 0.3 per cent at 12.30pm (AEST), against gains of 0.9 per cent just prior to the S & P announcement.

IG chief markets strategist Chris Weston said S & P’s move was a surprise only due to its timing, coming before the election result is known.

“There seems a good chance Australia will lose its AAA rating held by S&P after the two-year review period, but we shouldn’t be concerned…this is semantics at best, although the Australian banks may see an impact in the wholesale funding markets,” he said.

Mr Weston added the market reaction mainly centred on financials, with the big four banks at one point trading around the flatline after an earlier rise of 1 per cent.

“Banks are where the stress can be seen, and traders and investors are clearly stating that funding costs are likely to go up as a consequence of any potential rating change,” he said.

“This could naturally have an impact on margins, although the banks seem fairly well prepared for this and have been active in the funding markets in the last 12 months.”

Treasurer Scott Morrison said Standard & Poor’s move reinforced the Coalition government’s long-held position that fiscal consolidation cannot be postponed or slowed, as Labor intended to do.

Mr Morrison said the Coalition would form government again over the next few “days or weeks” and had every intention of maintaining the credibility of our AAA rating.

“It would be not the responsible thing to do in this environment to take policy decisions that would increase the deficit particularly, in (Labor’s) words, over the next few years,” Mr Morrison said.

“Because once you have run up a high deficit over the next couple of years, that increases the debt and you can’t get that money back.”

Mr Morrison stressed the the S&P classification was a “negative watch” and not a downgrade, and urged calm.

“I think it is a time for sobriety when it comes to responding to these measures,” Mr Morrison said.

Mr Morrison maintained the Coalition’s company tax cuts would boost economic growth, and emphasised that S&P’s position was based on concerns about the uncertain outcome of the election, and not about the Coalition’s budget.

With Rachel Baxendale