Ratings downgrade threat looms, but stocks edge up

Australia is ‘almost certain’ to lose its AAA credit rating, and NSW, Victoria and big banks also face downgrades.

S&P has put Australia’s sovereign AAA rating on negative watch.

Australia is “almost certain” to lose its prized AAA credit rating in coming years, economists have warned, in a move that will trigger a round of ratings downgrades across the NSW and Victorian governments as well as the big four banks.

Even so, investors looked through the warning by Standard & Poor’s, which yesterday put the country’s prized AAA credit rating on negative outlook, blaming years of federal budget deficits.

Along with the downgrading of the outlook on the sovereign rating, S&P also lowered the outlook on the AAA credit rating for NSW, Victoria and the ACT to negative, along with the outlooks for the big four banks, which now have a period of two years to find out if the ratings agency will strip them of their coveted AA- rating.

Markets took the downgrading of the credit outlooks in their stride, suggesting investors had softened their view on ratings changes.

The yield on 10-year Australian government bonds ­increased by 3 basis points immediately following the announcement, but closed where they had started the session at 1.86 per cent — just shy of a ­record-low hit on Wednesday.

The Australian dollar initially plunged about half a US cent, but soon recovered to finish the day flat at US75c, while the local stockmarket edged up 0.6 per cent to 5227.9 points.

The share prices of the big banks, which may act as a conduit for higher funding costs should Australia lose its credit rating, fell slightly from intraday highs but still managed to break a four-day losing streak. ANZ closed 0.4 per cent stronger, CBA lifted 0.7 per cent, Westpac rose 0.5 per cent, while NAB bucked the trend to end 0.2 per cent lower.

“It’s a warning shot to the Australian government,” UBS Asset Management’s head of investment strategy Tracey McNaughton told The Australian.

“I think it’s almost certain we’ll get downgraded, but whether it will have any material impact on the Australian dollar or on bond yields — in the current investment environment — in questionable,” she said. “In this environment, Australia is still a very attractive destination for investors.”

Commonwealth Bank’s top credit analyst Scott Rundell said one surprise in the largely expected warning was that S&P did not wait until there was clarity about the election result before making its threat.

“The trajectory of government debt had put Australia outside of the AAA ratings range, but S&P left Australia at AAA purely at goodwill. It appears now, given the parliamentary uncertainty, that they’ve lost patience and they’ve put it on negative outlook,” Mr Rundell said. In its comments S&P said the change in its outlook was due to “the prospects for improvements in budgetary performance” weakening following the recent election outcome.

S&P had previously warned that Australia needed to deliver the forecast improvement in its budgetary situation and return the budget to a balanced position by the early 2020s, to remain consistent with a AAA rating.

Mr Rundell said being placed on negative watch may add a little extra volatility to local financial markets, but that would likely be drowned out by other sources of turbulence such as the fallout from Brexit, or the prospect of a Trump presidency.

“If the market doesn’t react you can either say the market had already priced it in or it doesn’t think the ratings agency will follow through with the downgrade. I think the market has bigger fishes to fry at the moment,” he said.

Australian Bankers’ Association chief Steven Munchenberg said the negative outlook was a step towards more economic uncertainty and could increase the price of money throughout the economy at a time when lenders were copping political heat over calls for a royal commission into the sector. “A royal commission into the banks is then a further step towards uncertainty and it’s not exactly what we need in these uncertain times,” Mr Munchenberg said.

Capital Economics chief Paul Dales said fears a downgrade would raise the borrowing costs of the government and the banks were overdone. “Nor should it weaken the dollar,” Mr Dales said. “Bond yields were much lower after Australia lost its AAA rating in 1986 than in the years before,” he said.

National Australia Bank chief markets economist Ivan Colhoun said previous research had found “no sustained impact” of credit ratings actions on other G10 currencies and there was “virtually no impact” on fixed income markets on yesterday.

“Even in the event of an eventual downgrade, Australian government borrowers and major banks will remain highly rated on a global basis,” he said.

Bond fund giant Pimco’s Australian head Robert Mead downplayed the impact on the commonwealth’s borrowing costs. “Commonwealth and other high quality bonds will remain a flight to safety asset,” he said.

Ms McNaughton said S&P’s action was “tough love” but was potentially what was needed to get politicians thinking longer term. “Maybe this is the downgrade Australia needed to have to wake the politicians from their slumber,” she said. “The triple AAA rating isn’t the be-all-and-end-all, (and) you shouldn’t be aiming for it at the detriment of longer-term economic fundamentals.”

Perpetual head of investment strategy Matt Sherwood said federal government didn’t need to react with “harsh austerity”, but needed to address the budget in a structured way “where growth is not endangered, corporations are encouraged to invest in capital and labour and households keep their precautionary savings low”.