Are the Brits headed for the PIGS sty?

By Colin Barr, senior writer


(Fortune) -- Is the United Kingdom in danger of being exiled to the island of misfit debtors?

For most of the past year, anxiety about overextended governments has focused on the southern European countries derisively known as the PIGS -- for Portugal, Italy, Greece and Spain. But the PIGS may soon have company.


U.K. officials this week released a budget that was short on cost-cutting details. Silence on that unpopular subject was hardly surprising, given the U.K. economy's slow recovery and the political jockeying ahead of a national election that is expected to take place in early May. The move wasn't the biggest stunner in a week that saw a downgrade in Portugal, squabbles over a Greek bailout and a selloff in long-dated U.S. government bonds.

Even so, observers warn of a squandered opportunity to quell fears over the cost of financing a recovery in the hard-hit U.K. economy. Government spending is on track to account for more than half of U.K. gross domestic product in 2010, while government debt is heading toward 64% of GDP next year, up from 44% in fiscal 2009.

"All in all, the budget has failed to upgrade the market's perceptions of the U.K. credit," Tullett Prebon economist Lena Komileva wrote in a note to clients this week. With the government yet to make unpopular spending cuts, "it is too early to suggest that an official downgrade of the U.K.'s AAA rating is unlikely."

Of course, it's also too early to suggest an official downgrade is likely. Moody's noted this month that while the highly leveraged U.K. and the U.S. governments face the biggest challenges in holding down their debt costs, they also have substantial flexibility.

Both are able to raise funds by selling debt denominated in their own currency, for instance, and have free floating currencies that can ease economic adjustments. The British pound has dropped 8% against the dollar this year.

What's more, in both countries, central bankers have taken it upon themselves to sop up hundreds of billions of dollars of government debt issuance during the crisis.

That sort of policy leeway has been sorely lacking in the peripheral nations of the euro zone. Joining the euro initially let the likes of Greece and Portugal borrow large sums at below-market rates, but it also left them with uncompetitive economies and no ability to restore competitiveness by devaluing their currencies.

That said, the monetary sponges are being put back on the shelf in the United States and the United Kingdom, leaving investors to wonder how much those governments will have to pay to raise money.

The past week has shown it's not an idle question. The yield on the 10-year U.S. Treasury note rose to 3.88% Thursday, up from 3.67% Monday.

That compares with a U.K. 10-year yield that has been steady this year at around 4% -- just above the comparable rates in Italy and Spain -- and a German rate of around 3.1%.

In any case, U.K. policymakers are going to have their work cut out for them after the spring elections -- which could make for an interesting May.

"While the chancellor acknowledged that the next public spending round will be the 'toughest for decades,' we do not appear to be any the wiser where exactly the axe will fall," IHS Global Insight economist Howard Archer said in a report this week. "It still seems that most of the details will not become clear until after the imminent general election." To top of page