Paris, October 16, 2020 -- Moody's Investors Service ("Moodys") has today downgraded
the government of the United Kingdom's long-term issuer and
senior unsecured ratings to Aa3 from Aa2. Concurrently, the
outlook has changed to stable from negative.
Moody's has also downgraded the Bank of England's long-term
issuer and senior unsecured bond ratings to Aa3 (from Aa2) and (P)Aa3
(from (P)Aa2) for the senior unsecured MTN programme. The P-1
short-term issuer rating is affirmed. The outlook on these
ratings has also changed to stable from negative.
The three key drivers for this action are closely related and mutually
reinforcing.
First, the UK's economic strength has diminished since we
downgraded the rating to Aa2 in September 2017. Growth has been
meaningfully weaker than expected and is likely to remain so in the future.
Negative long-term structural dynamics have been exacerbated by
the decision to leave the EU and by the UK's subsequent inability
to reach a trade deal with the EU that meaningfully replicates the benefits
of EU membership. Growth will also be damaged by the scarring that
is likely to be the legacy of the coronavirus pandemic, which has
severely impacted the UK economy.
Second, the UK's fiscal strength has eroded. General
government debt, already high and sticky prior to the crisis,
has risen further as a result of the pandemic. While the UK's
reserve currency status provides a high capacity to carry debt,
the material increase in debt poses risks to debt affordability in future
years, particularly in the absence of a clear plan to reduce government
indebtedness. Notwithstanding recent statements of intent by the
government, it is in Moody's view unlikely that the government will
be able meaningfully to rebuild the UK's fiscal strength in the
coming years given the low growth environment and the likely political
obstacles to doing so.
The third driver relates to the weakening in the UK's institutions
and governance that Moody's has observed in recent years,
which underlies the previous two drivers. While still high,
the quality of the UK's legislative and executive institutions has
diminished in recent years. Policymaking, particularly with
respect to fiscal policy, has become less predictable and effective.
Looking forward, the self-reinforcing combination of low
potential growth and high debt in a fractious policy environment will
create additional headwinds to addressing the economic, fiscal and
social challenges that the UK faces.
The stable outlook reflects the UK's intrinsic economic and institutional
strengths as well as Moody's expectations that the debt will stabilise
at its current level.
The foreign and local currency bond ceilings and the local-currency
deposit ceiling remain unchanged at Aaa. The foreign-currency
long-term deposit ceiling has been lowered to Aa3 from Aa2,
and the short-term foreign-currency bond and bank deposit
country ceilings remain at P-1.
Please click on this link https://www.moodys.com/viewresearchdoc.aspx?docid=PBC_ARFTL434583
for the List of Affected Credit Ratings. This list is an integral
part of this Press Release and identifies each affected issuer.
RATINGS RATIONALE
RATIONALE FOR DOWNGRADE TO Aa3 FROM Aa2
FIRST DRIVER: ECONOMIC GROWTH IS LIKELY TO BE MEANINGFULLY WEAKER
GOING FORWARD THAN ASSUMED IN THE Aa2 RATING
The first driver of Moody's decision to downgrade the UK's
government bond rating to Aa3 is the rating agency's view that economic
growth will remain meaningfully weaker going forward than was expected
when the rating was downgraded to Aa2 in September 2017, presenting
an obstacle to a material reversal in the UK's debt burden.
Even before the coronavirus-induced shock, a combination
of persistently low productivity growth since the global financial crisis,
tepid business investment since the June 2016 EU referendum, and
prolonged uncertainty over the eventual future trading relationship with
the EU were weighing on the UK's growth performance. Even
if there is a trade deal between the UK and EU by the end of 2020,
it will likely be narrow in scope and therefore the UK's exit from
the EU will, in Moody's view, continue to put downward
pressure on private investment and economic growth.
The coronavirus-induced shock has brought new and considerable
pressures on the UK economy. Despite the projected recovery,
we estimate a sharper peak-to-trough contraction for the
UK than for any other G-20 economy because of the relatively greater
severity of the coronavirus outbreak, the reliance of the UK economy
on service activities which involve greater levels of human interaction,
and the continued risk of further outbreaks and localized restrictions.
Moody's forecasts also reflect the view that lingering Brexit uncertainty
will hold back the recovery in the second half of the year. The
structural impact of the coronavirus-induced shock will be uncertain
for some time, but in view of the impact on investment and the labour
market to-date, some permanent scarring on the economy appears
likely.
SECOND DRIVER: DETERIORATION IN THE UK'S FISCAL STRENGTH WILL
BE CHALLENGING TO UNWIND, POSING RISKS TO DEBT AFFORDABILITY
The second driver of the downgrade is Moody's expectation that the
UK's public finances will remain weaker going forward than we expected
when we downgraded the rating to Aa2 in September 2017. That reflects
not just the significant increase in government debt related to the coronavirus-induced
shock, but the more expansionary fiscal policy stance underway even
before the pandemic. Spending pressures and Brexit uncertainty
present additional risks to fiscal outcomes.
One mitigant is high debt affordability; despite the much higher
issuance of government debt, the UK's funding environment and interest
costs are likely to remain benign. Moody's base case is that
interest rates will remain low for longer. That said, the
UK's debt affordability is not immune to shocks and the structure
of the UK's debt stock is less robust to increases in funding costs
than it once was due to the issuance of an unusually large proportion
of short-dated gilts.
Moody's expectation is that the broad deterioration in the UK's
fiscal position will not be rapidly reversed. Relative to peers,
the UK's fiscal policy effectiveness and the predictability and
cohesion of policymaking have weakened, reducing the likelihood
that the fiscal loosening stemming from the pandemic will be corrected
in a timely manner. Spending pressures are unusually large and
-- importantly - predate the coronavirus-induced shock.
The government is running out of space to cut spending in areas of discretionary
spending that are not protected. This implies that the government
will have limited ability to cut in areas that are not ring-fenced
without instituting some revenue-raising measures or coming up
against some very significant political obstacles. Higher expenditure
could be financed through higher taxation, though the timing and
magnitude of any such changes will difficult to manage given that they
will likely balance the need for fiscal consolidation against an equally
important desire to not choke off a nascent economic recovery.
THIRD DRIVER: WEAKER INSTITUTIONS UNDERLY BOTH OF THE AFOREMENTIONED
TRENDS
The third factor informing today's rating action is Moody's
view that the UK's weakened institutional policy effectiveness,
an element that the rating agency considers a governance factor under
its ESG framework, makes these credit challenges more difficult
to tackle.
This reduced institutional capacity to manage change in a predictable
and confidence-building manner is evident with respect to the UK's
approach to Brexit, in its inability to achieve an outcome which
meaningfully replicates the benefits of EU membership and in its approach
to implementing the agreement reached with the EU to date. However,
the erosion in the predictability of policymaking and respect for rules
and norms is perhaps most clearly reflected in the conduct of fiscal policy.
Some fiscal institutions, such as the Office for Budget Responsibility,
remain very strong relative to global peers. However, 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. This deterioration in the quality of institutions
has made policy planning more unpredictable.
The UK effectively has no fiscal policy anchor. Before the pandemic,
Moody's saw 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. While the economic
and public health uncertainties are undeniable at the current juncture,
there is no indication that this trend—which has transcended electoral
cycles—is likely to reverse.
RATIONALE FOR STABLE OUTLOOK
The stable outlook reflects Moody's view that the upside and downside
risks are balanced, at least over the coming 12-18 months.
The UK's intrinsic economic and institutional strengths, as well
as the likely level where debt will stabilize, compare well to peers
at the Aa3 rating level.
ENVIRONMENTAL, SOCIAL, AND 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 material 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. Moody's also regard the coronavirus outbreak
as a social risk under our ESG framework, which will have a significant
negative impact on the UK's growth and fiscal metrics.
Governance factors are a material driver of the rating. On a global
basis, the UK's governance institutions are strong,
supporting the Aa3 rating for now. However, the deterioration
observed in recent years is a key driver for the rating downgrade.
GDP per capita (PPP basis, US$): 48,727 (2019
Actual) (also known as Per Capita Income)
Real GDP growth (% change): 1.3% (2019 Actual)
(also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 1.3%
(2019 Actual)
Gen. Gov. Financial Balance/GDP: -2.1%
(2019 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -4.3% (2019 Actual)
(also known as External Balance)
External debt/GDP: [not available]
Economic resiliency: a1
Default history: No default events (on bonds or loans) have been
recorded since 1983.
On 13 October 2020, 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 institutions and governance strength, 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.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
The UK's outlook, and ultimately its rating could improve
if there were indications that the apparent erosion in institutional strength
is reversing. In particular, indications that British institutions
are reverting to the capability and predictability that has traditionally
characterised the UK's institutional framework would be positive.
Such an outcome would most likely be characterised by the development
of a credible strategy to achieve medium-term fiscal objectives
that rebuild the UK's fiscal strength. Passage of economic
policies that could sustainably boost growth potential would also be credit
positive.
The UK's rating would likely come under downward pressure if Moody's
were to conclude that the UK's fiscal strength was likely to deteriorate
due to growth pressures, higher-than-expected deficits,
or higher funding costs. A further structural weakening in economic
fundamentals would also undermine the UK's credit profile.
While it is unlikely at this stage, indications that sterling's
status as a reserve currency was in question would also exert downward
pressure on the outlook and eventually the rating.
The principal methodology used in these ratings was Sovereign Ratings
Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631.
Alternatively, 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
The List of Affected Credit Ratings announced here are a mix of solicited
and unsolicited credit ratings. Additionally, the List of
Affected Credit Ratings includes additional disclosures that vary with
regard to some of the ratings. Please click on this link https://www.moodys.com/viewresearchdoc.aspx?docid=PBC_ARFTL434583
for the List of Affected Credit Ratings. This list is an integral
part of this Press Release and provides, for each of the credit
ratings covered, Moody's disclosures on the following items:
• Rating Solicitation
• Issuer Participation
• Participation: Access to Management
• Participation: Access to Internal Documents
• Disclosure to Rated Entity
• Endorsement
• Lead Analyst
• Releasing Office
For further specification of Moody's key rating assumptions and
sensitivity analysis, see the sections Methodology Assumptions and
Sensitivity to Assumptions in the disclosure form. Moody's
Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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.
Moody's general principles for assessing environmental, social
and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s)
announced and described above.
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/Sub Sovereign
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
