Paris, November 08, 2019 -- Moody's Investors Service ("Moody's") has today
changed the outlook on the Government of the United Kingdom's Aa2
ratings to negative from stable. Concurrently, Moody's
has affirmed the Aa2 long-term issuer and senior unsecured ratings.
The outlook on the Bank of England's Aa2 issuer and senior unsecured
bond ratings and the (P)Aa2 on its senior unsecured MTN programme has
also changed to negative from stable; the Aa2 and (P)Aa2 ratings
have been affirmed. The short-term issuer ratings have been
affirmed at Prime-1.
The change in outlook to negative from stable is driven by two factors:
1. UK institutions have weakened as they have struggled to cope
with the magnitude of policy challenges that they currently face,
including those that relate to fiscal policy.
2. The UK's economic and fiscal strength are likely to be
weaker going forward and more susceptible to shocks than previously assumed.
The affirmation of the UK's Aa2 sovereign ratings balances the credit-supportive
factors such as wealth, economic diversification, a sound
monetary policy framework and a highly flexible labour market against
constraints such as a high debt burden and weak productivity growth.
The foreign and local currency bond ceilings and the local-currency
deposit ceiling remain unchanged at Aaa. The foreign-currency
long-term deposit ceiling remains Aa2, and the short-term
foreign-currency bond and bank deposit country ceilings remain
at P-1.
RATINGS RATIONALE
RATIONALE FOR NEGATIVE OUTLOOK
FIRST DRIVER: UK INSTITUTIONAL CAPACITY AND COMMITMENT TO FISCAL
DISCIPLINE HAVE WEAKENED
The increasing inertia and, at times, paralysis that has characterized
the Brexit-era policymaking process has illustrated how the capability
and predictability that has traditionally distinguished the UK's
institutional framework has diminished. Events in the House of
Commons in recent months have revealed legislators, policymakers
and administrators to be unable to arrive at the consensus needed to achieve
either a broadly acceptable approach to Brexit, or the continuation
of policy in other important areas, for example to address challenges
relating to education, productivity, or investment in infrastructure.
Brexit has been the catalyst for this erosion in institutional strength,
which can also be seen in, among other things, the small but
significant weakening of Worldwide Governance Indicators for Government
Effectiveness and Rule of Law. It is likely to remain so for some
time to come given the inevitably contentious nature of the negotiations
regarding a permanent set of trading arrangements with the EU.
And it would be optimistic to assume that the previously cohesive,
predictable approach to legislation and policymaking in the UK will return
once Brexit is no longer a contentious issue, however that is achieved.
The decline in institutional strength appears to Moody's to be structural
in nature and likely to survive Brexit given the deep divisions within
society and the country's political landscape.
This broad erosion in the predictability and cohesion of policymaking
is mirrored in areas of policy that are significant from a credit perspective.
Most importantly, the UK's broad fiscal framework, characterized
by features such as multi-year budget plans and more detailed revenue
and spending decisions announced for the outer years of the planning period,
has weakened. Following the significant fiscal consolidation that
took place between 2010 and 2015, more recent years have seen an
increasing willingness to move the goalposts, with changes to the
longer-term fiscal anchor and the definition of fiscal targets
and a revealed preference to shift the fiscal tightening to outer years
of a five-year horizon. Successive governments have announced
large, permanent increases in public expenditures, most notably
a large increase in spending on the National Health Service (NHS),
outside the normal calendar for fiscal policy changes and without detailed
policy plans.
Over the longer term, institutional weakening may also impact the
UK's economic strength, through its effect on the investment
climate and on the UK's attractiveness to skilled and unskilled
foreign labour. In recent years, we have already seen the
negative impact this can have, and Moody's expects this negative
influence will likely endure as the exit process continues and uncertainties
persist during the subsequent phase of trade negotiations with the EU
and with other nations.
This deterioration in the quality of institutions has made policy planning
more opaque and unpredictable. The independent Office for Budget
Responsibility (OBR) has noted that policy risks to the public finances
are now significant and are greater than they were two years ago.
Going forward, no matter what the outcome is of the general election
Moody's sees widespread political pressures for higher expenditures
with no clear plan to increase revenues to finance this spending.
In Moody's view, the commitment to maintaining a predictable,
prudent fiscal framework and associated policy settings that has characterized
the UK's credit profile until now is weakening in a way that will
transcend electoral cycles as pressures from the electorate for improved
public services continue to rise.
SECOND DRIVER: A LIKELY DETERIORATION IN FISCAL AND ECONOMIC STRENGTH
The weakening of the fiscal policy environment is evident in the data.
Even after years of fiscal consolidation, the country remains highly
indebted, with gross general government debt being only marginally
below its 2015 peak of 86.9% of GDP, and unlikely
to fall significantly over the medium term. In Moody's baseline
projections, the UK's general government debt is set to stay
broadly unchanged at around 85% of GDP over the next 3-4
years, absent any unexpected economic shocks. While that
is a lower level than assumed when Moody's downgraded the UK's
rating to Aa2 in September 2017, the trajectory has changed.
Then, Moody's expected a gradual decline in the debt burden
over the longer term. Now, Moody's sees little appetite
or opportunity for that to happen.
Indeed, the risks are that debt will begin to rise. In the
current political climate, Moody's sees no meaningful pressure
for debt-reducing fiscal policies. In fact, there
is rising pressure for spending increases with little apparent clarity
as yet on how they might be financed through additional revenues and little
scope for politically acceptable expenditure cuts. While greater
public investment could be growth-enhancing, there is no
appetite to address important areas of rigidity in public expenditure,
particularly health and social care, which will be key sources of
future financial pressure. In June 2018, the government pledged
real annual increases on average of 3.4% for the NHS for
the next five years. Even that expenditure increase may not be
sufficient to achieve the longer-term objective of improving standards.
In recent years, the government has consistently had to accommodate
higher spending by the NHS, and the OBR projects that health spending
will nearly double as a proportion of GDP over the coming decades.
The large and sticky debt burden is a key source of fragility for the
UK's credit profile, particularly at the current juncture,
when external threats to growth are rising and internal growth momentum
is slowing.
The magnitude of the fiscal challenge may well be amplified by weaker-than-expected
growth. Since the EU referendum, UK business investment (which
accounts for more than half of gross fixed capital formation) has contracted
by more than 1% in real terms, in contrast to the growth
that Moody's has observed in other advanced economies. This
shortfall does not just affect current growth rates. The persistent
weakness of business investment, combined with firms' bias
towards hiring as a more flexible way to increase capacity, has
resulted in limited capital deepening—a trend that will further
intensify the UK's existing productivity challenges over the longer
term. The UK economy has already experienced low productivity growth
since the global financial crisis, compared to previous cycles and
also other advanced economies.
This weakness in investment has taken place despite broadly favourable
credit conditions and limited spare capacity. It is unlikely to
reverse quickly; Brexit-related uncertainty as to future policy
settings and the UK's relationship with trading partners is unlikely
to diminish much even in the event that a deal is struck, given
the significant challenges it is now clear will be inherent in agreeing
any sort of longer-term trade agreement with the EU. Even
if the UK leaves the EU under the terms of a revised Withdrawal Agreement,
the two sides will still have to go through difficult and lengthy negotiations
around the terms of their future relationship. Negotiations with
other key trading partners are unlikely to be any more straightforward.
These trends leave the UK more vulnerable to shocks, and the debt
burden is sensitive to both growth and fiscal shocks. A deterioration
in growth and the fiscal performance as well as a rise in interest rates
or inflation would cause the debt burden to rise not fall. In Moody's
view, adverse fiscal outcomes would have the most impact,
followed by a reduction in growth.
RATIONALE FOR AFFIRMATION OF Aa2 RATINGS
The factors supporting the affirmation of the UK's Aa2 sovereign
rating include economy's significant strength, which is a
function of its large size, diversification, and flexibility.
The government also enjoys very low financing risks and a very high average
debt maturity. While the UK's institutions have weakened,
in part due to the serious challenges raised by Brexit, they remain
strong in comparison to global peers and the monetary policy framework
and central banking arrangements continue to be excellent.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Moody's takes account of the impact of environmental (E),
social (S), and governance (G) factors when assessing sovereign
issuers' economic, institutional and fiscal strength and their
susceptibility to event risk. In the case of the UK, the
materiality of ESG to the credit profile is as follows.
Environmental considerations are not currently material to the rating.
Social factors are taken into account in determining the UK's credit
profile. The most relevant social factors relate to spending pressures
on healthcare and pensions due to an ageing population. Over the
longer term, demographic pressures will (as in many peers) negatively
influence potential growth in the absence of increases in productivity,
in participation rates or in immigration.
Governance factors are a material driver of the rating. On a global
basis, the UK's governance institutions are strong,
supporting the Aa2 rating for now. However, the deterioration
observed in recent years is a key driver for the negative outlook.
WHAT COULD CHANGE THE RATING UP/DOWN
The UK's rating would likely be downgraded if we were to conclude
that policymakers' capacity and appetite to develop a credible medium-term
debt-reduction strategy was low. This would be particularly
negative for the UK's credit quality if, in our view,
that reflected a continued overall erosion in the coherence and predictability
of UK policymaking. Structurally weaker economic fundamentals would
also undermine the UK's credit profile. In that context,
departure from the EU without a deal would be strongly negative for the
rating. However, even if some form of withdrawal agreement
were to be signed, indications that the UK would not be able to
replace the very favourable trading arrangements embedded in EU membership
with similarly advantageous agreements with key trading partners in Europe
and elsewhere would also be negative for the rating.
Given the negative outlook on the UK's rating, an upgrade
is unlikely in the short to medium term. However, indications
that the apparent erosion in institutional strength is in fact reversible
and that the coming years will see a reversion to the capability and predictability
that has traditionally characterized the UK's institutional framework
would support the rating at its current level. Such an outcome
would most likely be characterised by the development of a credible strategy
to achieve medium-term fiscal objectives that put the debt burden
on a downward trajectory. Passage of economic policies that could
sustainably boost growth potential would also be credit positive.
GDP per capita (PPP basis, US$): 45,741 (2018
Actual) (also known as Per Capita Income)
Real GDP growth (% change): 1.4% (2018 Actual)
(also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 2% (2018
Actual)
Gen. Gov. Financial Balance/GDP: -2.3%
(2018 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -4.3% (2018 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 05 November 2019, 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 materially decreased.
The issuer's institutional strength/framework, have materially decreased.
The issuer's fiscal or financial strength, including its debt profile,
has materially decreased. The issuer's susceptibility to event
risks has not materially changed.
The principal methodology used in these ratings was Sovereign Bond Ratings
published in November 2018. Please see the Rating 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, category/class of
debt or security this announcement provides certain regulatory disclosures
in relation to each rating of a subsequently issued bond or note of the
same series, category/class of debt, security 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.
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.
Sarah Carlson, CFA
Senior Vice President
Sovereign Risk Group
Moody's France SAS
96 Boulevard Haussmann
Paris 75008
France
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Releasing Office:
Moody's France SAS
96 Boulevard Haussmann
Paris 75008
France
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
