London, 22 September 2017 -- Moody's Investors Service, ("Moody's") has
today downgraded the United Kingdom's long-term issuer rating
to Aa2 from Aa1 and changed the outlook to stable from negative.
The UK's senior unsecured bond rating was also downgraded to Aa2
from Aa1.
The key drivers for the decision to downgrade the UK's ratings to
Aa2 are as follows:
1. The outlook for the UK's public finances has weakened
significantly since the negative outlook on the Aa1 rating was assigned,
with the government's fiscal consolidation plans increasingly in
question and the debt burden expected to continue to rise;
2. Fiscal pressures will be exacerbated by the erosion of the UK's
medium-term economic strength that is likely to result from the
manner of its departure from the European Union (EU), and by the
increasingly apparent challenges to policy-making given the complexity
of Brexit negotiations and associated domestic political dynamics.
Concurrently, Moody's has also downgraded to Aa2 the Bank
of England's issuer and senior unsecured bond ratings from Aa1.
The rating on its senior unsecured medium-term note (MTN) program
was downgraded to (P)Aa2 from (P)Aa1. The short-term issuer
ratings were affirmed at Prime-1. The ratings outlook was
also changed to stable from negative.
The foreign and local currency bond ceilings and the local-currency
deposit ceiling remain unchanged at Aaa/P-1. The foreign-currency
long-term deposit ceiling was lowered to Aa2 from Aaa, and
the short-term deposit ceilings remain P-1.
RATINGS RATIONALE
RATIONALE FOR THE DOWNGRADE TO Aa2
FIRST DRIVER: WEAKENING PUBLIC FINANCES WITH HIGHER BUDGET DEFICITS
IN THE COMING YEARS AMID PRESSURE TO RAISE SPENDING
Moody's expects weaker public finances going forward, partly
linked to the economic slowdown under way but also reflecting the increasing
political and social pressures to raise spending after seven years of
spending cuts. Since 2015, the government has been finding
it increasingly difficult to implement the spending cuts that it has been
targeting, in particular on welfare spending. More recently,
the government has yielded to pressure and raised spending in several
areas, including for health and adult social care. It also
agreed to above-budget pay increases for some public sector workers.
While these additional expenditures will be funded out of current budgets,
the pressure to continue to increase spending in the coming years is likely
to remain high, in particular on health care and the public sector
wage bill.
In addition, in order to secure a working parliamentary majority,
the new government agreed a 'confidence and supply' arrangement
that increases public spending by GBP1 billion for Northern Ireland.
It also abandoned a pre-election promise to review the costly so-called
"triple lock" on state pensions after 2020. Overall,
Moody's expects spending to be significantly higher than under the
government's current budgetary plans and higher than the rating
agency expected when the negative outlook was assigned in June 2016.
At the same time, revenues are unlikely to compensate for higher
spending. Earlier this year, the government abandoned a planned
increase in national insurance contributions for the self-employed.
Instead, the government has become reliant on highly uncertain revenue
gains from tackling tax avoidance to fund tax cuts, as the Office
for Budget Responsibility recently pointed out. Hence, while
last year's general government budget deficit turned out somewhat
lower than expected (3.0% of GDP on a calendar year basis),
Moody's expects the (general government) budget deficit to remain
at levels of 3-3.5% of GDP in the coming years,
against the government's plan of a gradual reduction to below 1%
of GDP by 2021/22.
The UK's broader fiscal framework -- previously one of the
strengths of the sovereign's credit profile -- has also weakened
in recent years as illustrated by repeated revisions to medium-term
fiscal targets and delays in reversing the rising debt trend. In
contrast to the government's earlier plans to have public sector
net borrowing in surplus by 2019-20, the current objective
is for the structural deficit to be below 2% by 2020-21;
and the supplementary objective of having net debt as a percentage of
GDP decline every year has been delayed to 2020-21 (from 2015-16
before). While these targets may be more realistic, the changes
signal weaker predictability.
Weaker public finances will imply a further delay in reversing the rising
public debt ratio. This places the UK among the few highly-rated
European sovereigns where the public debt ratio continues to rise.
Moody's expects the ratio to increase to close to 90% of
GDP this year and to reach its peak at close to 93% of GDP only
in 2019, two years later than the latest government plans.
Moreover, while the UK government benefits from one of the longest
average maturities of its debt stock among advanced economies, the
cost of the debt is comparatively high with Moody's preferred metric
-- interest payments as a share of government revenues -- at
6.3% compared to a ratio of around 3.6% for
most other Aa2-rated peers.
SECOND DRIVER: EROSION OF ECONOMIC STRENGTH AS A RESULT OF EU EXIT
DECISION AND INCREASING CHALLENGES TO POLICYMAKING
Moody's believes that the UK government's decision to leave
the EU Single Market and customs union as of 29 March 2019 will be negative
for the country's medium-term economic growth prospects.
Aside from the direct impact on the UK's credit profile, the
loss of economic strength will further exacerbate pressures on fiscal
consolidation.
Growth has slowed in recent months, with average quarterly growth
of just 0.26% in the first two quarters, versus an
average of 0.6% over the 2014-2016 period.
Private consumption has slowed sharply and business investment has been
weak since 2016, most likely linked to the Brexit-related
uncertainty. While future years may see some recovery, Moody's
expects growth of just 1% in 2018 following 1.5%
this year and 2.25% on average in recent years.
More importantly for the UK's credit profile, Moody's
does not expect growth to recover to its historic trend rate over the
coming years. The UK is a relatively open economy, and the
EU is by far its largest trading partner. Research by the National
Institute of Economic and Social Research (NIESR) suggests that leaving
the Single Market will result in substantially lower trade in goods and
services with the EU. In a similar vein, both the NIESR and
the Bank of England estimate that private investment will be materially
lower in the coming years than in a non-Brexit scenario.
Moody's is no longer confident that the UK government will be able
to secure a replacement free trade agreement with the EU which substantially
mitigates the negative economic impact of Brexit. While the government
seeks a "deep and comprehensive free trade agreement" with
the EU, even such a best-case scenario would not award the
same access to the EU Single Market that the UK currently enjoys.
It would likely impose additional costs, raise the regulatory and
administrative burden on UK businesses and put at risk the close-knit
supply chains that link the UK and the EU. Also, free trade
arrangements do not as a standard cover trade in services -- which
account for close to 40% of the UK's exports to the EU and
80% of Gross Value Added in the economy -- given the prevalence
of non-tariff trade restrictions and the need to align regulations
and standards. In Moody's view, the differences of outlook
between the UK and the EU suggest that the most likely outcome is now
a rather more limited free trade agreement which may exclude services:
the UK's desire to pursue its own regulatory policies and to avoid
the jurisdiction of the European Court of Justice will make finding an
agreement on services challenging. Moreover, any free trade
agreement will likely take years to negotiate, prolonging the current
uncertainty for businesses.
Aside from the direct impact on the UK's credit profile, weakening
growth prospects are likely to exacerbate the government's evident
fiscal challenges. And this is likely to be happening during a
period in which policymakers will be increasingly distracted by the twin
challenges of sustaining a domestic political consensus on how to operationalise
Brexit and reaching agreement with EU counterparts.
Brexit carries with it a heavy policy and legislative agenda which will
dominate policymaking in the years to come. In addition to ensuring
a smooth exit from the EU, the UK authorities aim for significant
changes to the UK's immigration policy, its broader trade
policies as well as regulatory policies. With Brexit dominating
the government's legislative priorities for the coming years,
there is likely to be limited political capital and civil service capacity
to address other challenges relating to the UK's growth potential
and weak productivity growth. While Moody's continues to
assess the UK's institutional strength to be very high, the
challenges for policymakers and officials are substantial and rising.
The recent loss of the UK government's parliamentary majority further
obscures the future direction of economic policy.
RATIONALE FOR STABLE OUTLOOK
The fiscal deterioration that Moody's expects is balanced by the
UK's continued economic and institutional strengths, that
compare well to peers at the Aa2 rating level. While the ongoing
Brexit negotiations introduce a high level of uncertainty over the economic
outlook for the UK, Moody's base case remains that some form
of a free trade agreement is in the interest of both sides and will ultimately
be agreed. Such a scenario would mitigate the negative economic
implications of the UK's departure from the EU to some extent.
In that context, Moody's notes that the UK government may
be softening its negotiating stance in a number of areas, including
on the European Court of Justice, on continuing budget contributions
in the transition phase and most importantly on the need for a transitional
agreement beyond March 2019 to limit the disruption to trade following
the UK's exit.
WHAT COULD CHANGE THE RATING UP/DOWN
The combination of eroding fiscal and economic strength which drove today's
action implies limited upside to the rating following the downgrade.
Over the longer term, a more rapid and sustained recovery in fiscal
strength, together with evidence that the economic impact of Brexit
is less material than Moody's currently estimates would be positive
for the rating.
The rating would come under further downward pressure if Moody's
concluded that public finances were likely to weaken further than Moody's
currently expects. It would also be under pressure if Moody's
concluded that the economic impact of the decision to exit the EU would
be more severe than Moody's currently expects, perhaps because
the negotiations with the EU failed to secure an effective transition
agreement that would allow for an orderly transition to new trade arrangements.
GDP per capita (PPP basis, US$): 42,481 (2016
Actual) (also known as Per Capita Income)
Real GDP growth (% change): 1.8% (2016 Actual)
(also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 1.6%
(2016 Actual)
Gen. Gov. Financial Balance/GDP: -3%
(2016 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -4.4% (2016 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 19 September 2017, 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 fiscal or financial strength, including its debt profile,
has materially decreased. Other views raised included: The
issuer's institutional strength/framework, have decreased.
Susceptibility to political event risk has increased.
The principal methodology used in these ratings was Sovereign Bond Ratings
published in December 2016. 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 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.
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
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 Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
