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Rating Action:

Moody's changes outlook on UK sovereign rating to negative from stable, affirms Aa1 rating

Global Credit Research - 24 Jun 2016

London, 24 June 2016 -- Moody's Investors Service has today changed the outlook on the UK's long term issuer and debt ratings to negative from stable. Both ratings are affirmed at Aa1.

Today's rating action reflects the following key drivers:

1. The majority vote in favour of leaving the European Union (EU) (Aaa, Stable) in the referendum held on 23 June will herald a prolonged period of uncertainty for the UK, with negative implications for the country's medium-term growth outlook. During the several years in which the UK will have to renegotiate its trade relations with the EU, Moody's expects heightened uncertainty, diminished confidence and lower spending and investment to result in weaker growth. Over the longer term, should the UK not be able to secure a favourable alternative trade arrangement with the EU and other countries, the UK's growth prospects would be materially weaker than currently expected.

2. While the UK's institutional framework will not change, Moody's considers that policy predictability and effectiveness of economic policy-making -- an important aspect of institutional strength - might be somewhat diminished as a consequence of the vote. The UK government will not only need to negotiate the UK's departure from the EU but will likely also aim to embark on significant changes to the UK's immigration policy, broader trade policies and regulatory policies. While we consider the UK's institutional strength to be very high, the challenges for policymakers and officials will be substantial.

3. As a consequence of the weaker GDP growth outlook and institutional strength, the UK's public finances will also likely be weaker than Moody's has assumed so far. In Moody's view, the negative effect from lower economic growth will outweigh the fiscal savings from the UK no longer having to contribute to the EU budget. The UK government has one of the largest budget deficits among advanced economies, and lower GDP growth will further complicate the implementation of the government's multi-year fiscal consolidation plan. Consequently, the public debt ratio will likely remain higher than the rating agency previously expected.

Concurrent with the rating action on the sovereign, Moody's has also changed the outlook to negative for the Aa1 rating of the Bank of England from stable. The Aa1/P-1 ratings were affirmed. The UK's long-term and short-term foreign and local-currency bond and deposit ceilings remain unchanged at Aaa/ P-1.

A full list of affected ratings is provided towards the end of this press release.

RATINGS RATIONALE

RATIONALE FOR NEGATIVE OUTLOOK

UK's MEDIUM-TERM GROWTH PROSPECTS COULD BE MATERIALLY WEAKER

The first driver for the change in outlook is the negative impact that Moody's believes the decision to leave the EU will have on the UK's growth prospects and economic strength. In the referendum held on 23 June, a majority of 52% of voters decided in favour of leaving the EU. This decision will set in motion a withdrawal process that will likely take several years to conclude: in addition to the formal withdrawal process, which should notionally take two years under the Lisbon Treaty provisions (although this can be extended), the UK will also have to negotiate a new trading arrangement with the EU, if it chooses to do so.

In Moody's view, many investment and spending decisions are likely to be put on hold during this period, given the high degree of uncertainty over the UK's future trade relationship with the EU. Financial conditions will likely be tighter as well, reflecting higher risk premia, which will increase the cost of financing. Moody's therefore expects real GDP growth to be roughly half a per cent lower in 2016 and roughly one per cent lower in 2017 than the agency's previous forecasts of 1.8% and 2.1% respectively, driven by materially lower investment and somewhat lower private consumption.

Over the medium term, the UK's economic growth prospects will depend crucially on what trade agreement the UK government reaches with the EU as well as on the UK government's trade policies more generally. The EU is the UK's biggest trading partner, with around 44% of exports destined for EU countries (2015 data), and 48% of foreign direct investment in the UK originating from the EU (2014 data). While the UK might be able to redirect its trade to other regions and thus compensate for lower trade with the EU, this will take time.

In a base case scenario, Moody's expects that the UK and the EU would come to an arrangement to preserve many -- but not all -- of the current trading relationships. However, there are clear downside risks. In the absence of a trade agreement that preserves core elements of the UK's current access to the Single Market, Moody's believes the UK's real GDP growth would be materially lower. Barriers to trade will not only result in lower trade but also negatively impact competition, innovation and productivity. Those effects would be particularly pronounced if the UK reverted to trading on a "most-favoured nation" basis with the rest of the world. In addition, the UK authorities will have to renegotiate the UK's trade relations with a multitude of other countries, as the UK will no longer automatically benefit from the more than 30 preferential trade agreements that the EU has concluded, covering nearly 60 countries.

PREDICTABILITY AND EFFECTIVENESS OF ECONOMIC POLICY-MAKING MIGHT BE DIMINISHED

The second driver for the outlook change to negative from stable is the risk that policy predictability and effectiveness might be somewhat diminished as a consequence of the vote. The UK government will not only have to negotiate the UK's departure from the EU, but will also have to agree a new trade relationship with the EU as well as with a large number of other countries and regions. It will probably also embark on significant changes to the UK's immigration policy and possibly regulatory policies, a challenging set of economic policy decisions under a new government leadership following the resignation of Prime Minister Cameron.

Moody's considers many aspects of the UK's institutional framework to be very strong, such as the rule of law, a strong fiscal framework as well as a highly credible central bank that has been successful in achieving its policy objective and a professional and highly qualified civil service. However, the decision to exit the EU will pose material challenges for policymakers and officials.

THE UK GOVERNMENT'S FISCAL STRENGTH WILL LIKELY BE LOWER

The third driver for the outlook change to negative from stable is the negative effect on the UK's public finances arising from lower economic growth.

Moody's sovereign rating of Aa1 for the UK is based on the expectation that the UK government will successfully implement a multi-year fiscal consolidation plan and bring the elevated general government debt ratio of over 89% of GDP (2015) on a declining trend from this year onwards. The government has already slowed the pace of fiscal consolidation materially compared to its original plans, and other things being equal lower growth will lead to lower revenues and higher expenditures, further challenging the government's ability to rebalance its books.

In addition, the change in leadership of the government and/or likely political pressures stemming from weaker growth create uncertainty around the fiscal stance in future years and increase the risk of a looser stance than the agency has assumed so far. In a pessimistic scenario, the budget deficit reduction could stall and the public debt would rise from current levels.

Moody's does not believe that the negative effects from lower growth will be fully compensated by the fiscal savings from the UK no longer having to contribute to the EU budget.

RATIONALE FOR AFFIRMATION OF THE UK'S Aa1 RATING

The economic and fiscal consequences of the referendum result are highly uncertain as they depend crucially on the outcome of future negotiations with the EU as well as with other trading partners. Moody's believes that a scenario in which the UK manages to preserve many (albeit not all) of its current trade benefits from EU membership is plausible. The long-term economic impact would be limited in such a scenario and the UK's current sovereign rating of Aa1 would remain appropriate.

Also, the UK authorities might well adopt policies that mitigate the above mentioned negative consequences of the decision to leave the EU. Those policies -- in the areas of trade, regulations, immigration, tax -- will become clearer over the coming 1-2 years.

WHAT COULD MOVE THE RATING DOWN/UP

The rating could be downgraded if the negotiations are protracted and suggest that the UK government is unlikely to conclude a trade agreement with the EU that will protect core elements of the UK's current access to the EU Single Market. The rating would also come under downward pressure if there is no further material progress in reducing the government's budget deficit, as this would leave the public debt burden close to the current levels in the next several years. A third driver for a downgrade of the rating could be the emergence of heightened pressures on the exchange rate in the context of substantial and persistent capital outflows, as this would raise questions over the funding of the UK's large current account deficit of more than 5% of GDP (2015) and more fundamentally over the role of Sterling as one of the few global reserve currencies.

The outlook could be returned to stable if Moody's concluded that the UK government is likely to be able to negotiate a trade arrangement with the EU that preserves core elements of the UK's current access to the Single Market. This in turn would limit the economic impact from the EU exit and allow for a continued improvement in the country's public finances and a gradual reduction of public debt over the coming years.

LIST OF AFFECTED RATINGS

Affirmations:

..Issuer: Bank of England

....LT Issuer Rating, Affirmed Aa1

....Senior Unsecured Regular Bond/Debenture, Affirmed Aa1

....Senior Unsecured MTN, Affirmed (P)Aa1

....ST Issuer Rating , Affirmed P-1

..Issuer: United Kingdom, Government of

....LT Issuer Rating, Affirmed Aa1

....Senior Unsecured Regular Bond/Debenture, Affirmed Aa1

Outlook Actions:

..Issuer: Bank of England

....Outlook, Changed To Negative From Stable

..Issuer: United Kingdom, Government of

....Outlook, Changed To Negative From Stable

The referendum outcome to leave the EU required the publication of this credit rating action on a date that deviates from the previously scheduled release date in the sovereign release calendar, published on www.moodys.com.

GDP per capita (PPP basis, US$): 41,159 (2015 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.3% (2015 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.2% (2015 Actual)

Gen. Gov. Financial Balance/GDP: -4.4% (2015 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -5.2% (2015 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: Very High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 24 June 2016, a rating committee was called to discuss the rating of the United Kingdom, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/framework, have decreased. The issuer's governance and/or management, have decreased. The issuer's fiscal or financial strength, including its debt profile, has decreased.

The principal methodology used in these rating was Sovereign Bond Ratings published in December 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Moody's considers a rated entity or its agent(s) to be participating when it maintains an overall relationship with Moody's. On this basis Government of United Kingdom or their agents are considered to be participating entities. These rated entities or their agents generally provide Moody's with information for their ratings process.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Kathrin Muehlbronner
Senior Vice President
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's changes outlook on UK sovereign rating to negative from stable, affirms Aa1 rating
No Related Data.
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