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Why a UK Downgrade Wouldn't Be a Big Deal

The downgrade of the U.K.'s credit rating by at least one of the three major ratings agencies: Moody's, Standard & Poor's or Fitch, looks increasingly likely in the New Year. Before gnashing of teeth and wailing begins, bear in mind that losing the triple-A crown may not be such a big deal after all.

Kimberley Coole | Lonely Planet Images | Getty Images

The most important fallout from a downgrade will probably be political. The country's finance minister George Osborne has hung his hat on the U.K. keeping its rating, and the opposition party is unlikely to spare his blushes if the hat stand gets shaky.

The triple-A rating survived economic blows like the 1978-9 "winter of discontent" which swept former U.K. Prime Minister Thatcher to power and Black Wednesday, when the Conservative government had to withdraw the British pound from the European Exchange Rate Mechanism (ERM).

George Osborne has consistently emphasized the importance of stabilising the U.K.'s debt and committing the country to austerity, with the maintenance of the top rating on government debt a key element of this.

There will be plenty of political capital to be made from arguing that the U.K. is worse off now than under the last administration, as parties head in to the second half of the current government's term and the next election emerges into sight.

Yet this may not be valid when the likely effects on a range of U.K. investments are considered. After an initial knee-jerk reaction to the news, most of the key U.K. markets would probably stabilise.

TheFTSE 100 is now so dominated by international companies, or U.K.-based companies which do most of their business abroad, that a downgrade probably wouldn't register much beyond a temporary blip.

The gilt market, too, should remain unperturbed. As HSBC analysts point out, because the U.K. can issue its own currency, it can always create money to finance debt, putting it at "almost zero" risk of a pure default on repaying that debt (although of course, money-printing brings its own problems).

U.K. bonds are more vulnerable to falls following a downgrade if the U.K.'s safe haven status is perceived to be under threat, although a one-notch downgrade, which at the moment appears to be the most likely outcome, is unlikely to send U.K. bonds into the kind of territory seen in many other parts of Europe.

Thepound's valuation could potentially suffer most from a downgrade, but a weakening currency might be no bad thing for U.K. exports.

Ultimately, downgrades have lost much of their power to shock the market, as can be seen by France's downgrade by Moody's last week. They are often both well-flagged and frankly, generally long-overdue, that they don't provoke the kind of negative reaction seen earlier in the credit crisis.

Written by Catherine Boyle, CNBC. Twitter: @cboylecnbc.

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