Today the Governor of the Bank of England, Mervyn King, announced that inflation may exceed 3% in the short term but will quickly drop back to less than 2%.  The main reason for this was the recent increase in VAT.

Mervyn King also added that the recovery in the UK economy will be slower than some had originally been forecasting.  He also went on to discuss UK’s AAA credit rating and saw no reason why this should change, but his speech contained a caveat regarding the election and what a future Government may seek to do.  In Mervyn King’s words, the AAA rating was ours to lose.

So why is the AAA rating so important to the UK economy?  There are two key and related factors here.

Firstly, the cost of UK borrowing would increase substantially if the credit rating was to fall below AAA.  Put simply the higher the perceived risk the higher the interest rate on borrowing.

Secondly, and perhaps more importantly, the effect of a fall in UK’s AAA credit rating would increase interest rates.  Higher interest rates, especially at a time of weak economic growth would slow the growth down even further and quite possibly create a longer recession.

So, it is good news to hear that UK’s AAA rating is “ours to lose”, let’s hope whoever gets elected looks after our credit rating!