Pound Euro Exchange Rate Lowest Since August 2011

A highly volatile start to the trading week saw the pound slump to its lowest level against the euro since August 2011 and to a 31 month low against the US dollar on the back of the news late on Friday night, after the markets had closed for the week that the credit ratings agency, Moody's Investors Service downgraded the government bond ratings of the UK by one notch from its prized Aaa status to Aa1. It is the first time since 1978 that the UK has been without its Aaa status.

Moody’s did however confirm that the outlook on the UK rating is now stable, versus the negative outlook it had been on since July 2012.

Moody’s justified its decision by citing:

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.

The other two main credit ratings agencies, Standard & Poor’s and Fitch will make their announcements later on this year.

Former Chancellor Kenneth Clarke said that the UK will take 'several years' to get back its Aaa credit rating as the right wing of the Tory party called on Chancellor George Osborne to change direction. Backbenchers said that the Chancellor should cut spending further, and reduce taxes and fuel duty in the wake of the decision by Moody’s. In contrast, Vince Cable, the Liberal-Democrat Business Secretary, said that a 'slash and burn' policy would be 'utterly foolish and counterproductive' and would not be taken up by the coalition.

Mr Clarke, the Minister without Portfolio in the current coalition government and a former Chancellor backed the approach adopted by the US, which lost its AAA rating in 2011. “The Americans, like us, are going to persist with sensible policies combining getting rid of the debt and deficit at the same time as stimulating growth and having an industrial strategy. It is going to take several more years of this to get back not just our credit rating but to sensible growth.”

Later in the day, the euro came under pressure, falling to a 6 week low against the dollar as investors grew increasingly nervous about the inconclusive Italian election results. Bond yields in both Italy and Spain, respectively the third and fourth largest economies in the euro zone have jumped above the key 5% level putting new pressure on the single currency.

Meanwhile, Bank of Greece Governor George Provopoulos said yesterday that the Greek economy is expected to contract by a further 4.5% this year and that an economic recovery will not begin until 2014. Provopoulos insisted that the country must move ahead with the reforms agreed in order to secure its bailout package.

"There is no doubt that 2013 will be a difficult year. Strict adherence to the targets will ensure continued funding and eliminate once and for all the risk of exit from the euro area, attract new investment and convey a clear message that the worst is behind us," said Provopoulos.

Provopoulos said that the recession should not be used an excuse to ease up on reform efforts.

The fresh developments in the euro zone could dent the very positive start to the year made by the stock and commodity markets as a fresh bout of the euro zone sovereign debt crisis could increase demand for safe haven currencies aiding flows into the US dollar, Swiss Franc and Japanese Yen.