DBRS Morningstar Confirms The United Kingdom At AAA, Stable

15th December 2019

DBRS Ratings GmbH (DBRS Morningstar) confirmed the United Kingdom of Great Britain and Northern Ireland's (the United Kingdom or U.K.) Long-Term Foreign and Local Currency - Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

DBRS Morningstar views that the outcome of the December 12th, 2019, U.K. general election brings more, but not full clarity to EU exit. The new majority Conservative government will likely expedite into legislation the Withdrawal Bill and exit the EU on January 31st, 2020. Next step, it must progress to agreeing a future EU relationship, working to a tight deadline of end-2020, although this date can be extended. On fiscal policy, DBRS Morningstar expects a more expansionary stance. Public spending as a share of GDP is likely to rise with new priorities and new fiscal rules have been proposed. In the coming months, the independent Office for Budget Responsibility (OBR) will publish economic and fiscal forecasts and Budget 2020 will be debated and put into law.

Key macroeconomic indicators thus far suggest the U.K. has demonstrated resilience through a long period of Brexit-related uncertainty and the economic slowdown has been manageable. GDP growth of 1.2% is expected this year, still in line with the OBR’s March forecast, and similar to this year’s GDP growth rates expected in other DBRS Morningstar AAA European sovereigns. The unemployment rate has levelled off at around 3.8% of the economically active population, similar to the U.S.A., another DBRS Morningstar AAA sovereign. The fiscal deficit will somewhat worsen in the current fiscal year, but the public debt ratio will likely marginally improve. Moreover, U.K. government funding costs have been historically low for an extended period of time.

DBRS Morningstar continues to maintain the U.K.’s AAA ratings and Stable Trends reflecting democracy, rule of law, freedom of speech, the courts, the size and resilience of the economy and the shock-absorbing benefits of the country’s own monetary policy and flexible exchange rate. HM Treasury and the Bank of England (BoE) oversee one of the world’s primary currencies and reserve assets. This facilitates low-cost local currency borrowing across a broad range of maturities, even during periods of investor risk aversion. The U.K.’s maturity structure of public debt at around 15 years is the longest average maturity in the G7, which means that debt repayments are spread over many years. This reduces any adverse funding impact of a temporary shock, should it emerge.

RATING DRIVERS

The U.K. ratings could come under downward pressure from one or a combination of the following factors (1) a significant increase in the likelihood of a break-up of the United Kingdom; (2) a Brexit outcome that materially diminishes economic resilience and erodes the government’s debt financing flexibility; or (3) economic and financial dislocations that undermine the financial system.

RATING RATIONALE

More Clarity on EU Withdrawal, but Still Uncertainty about the Future Relationship

When the second Withdrawal Agreement between the EU and the U.K. was not legislated by the U.K. parliament this Autumn, a general election was called in an attempt to resolve the deadlock. The new Conservative government will likely attempt to put into legislation the existing withdrawal agreement, which avoids the hard Irish border as soon as possible, prior to the new Brexit day of 31st January 2020. This date marks the third extension of the Brexit timeline, and highlights deep divisions that developed between the political parties and the broader public around Brexit. DBRS Morningstar considers delays and over-focus on Brexit as evidence of some weaker capacity to address economic challenges, resulting in a negative qualitative adjustment in DBRS Morningstar’s "Political Environment" building block.

Difficulties with preserving the Union in a leave scenario were evident in the divergent outcomes among the U.K. constituent countries in the 2016 EU referendum vote when England (53.4%) and Wales (52.5%) voted to leave and Northern Ireland (55.8%) and Scotland (62.0%) voted to remain. Nationally, as a share of the total electorate, around 37% voted to leave the EU. See DBRS Morningstar Commentaries: “No-Deal Brexit Heightens Risks of Break Up of the UK” and “No-Deal Brexit Heightens Risks for the Island of Ireland”, 4 September 2019. DBRS Morningstar notes yesterday’s strong election result for the Scottish National Party and will continue to look to demographics, opinion polls and the likelihood of holding referendums, in order to establish the future possibility of Scottish independence, or Irish re-unification.

The Economy has Slowed, but the U.K. Unemployment Rate Remains Very Low

The U.K. is the fifth-largest economy in the world and is one of the most advanced, with strong economic performance in past years. However, headline growth has moderated recently, as Brexit-related uncertainty weighs on business investment and net trade. The latest OBR forecast in March was for economic growth of 1.2% this year, compared with 1.4% in 2018 and 1.9% in 2017. There are downside growth risks, however, stemming from domestic and external factors, and DBRS Morningstar acknowledges the risk of a technical recession in the event that the transition date passes without agreement on a future relationship. Employment continues to grow this year and the unemployment rate at 3.8% is the lowest rate since 1975. The employment rate is at a near joint record of 76% of all people aged from 16 to 64 years. In the longer term, however, the economic impact of the U.K.’s exit could adversely impact trade, investment and migration, leading to potential growth slippage that could negatively impact long term debt dynamics. Other economic risks come from evolving global protectionist policies.

The Fiscal Position is Sound

The U.K.’s fiscal framework is transparent, supported by flexible fiscal rules and the independent OBR publishing its economic forecasts. Since 2010, material progress was made in reducing the Maastricht treaty deficit, from 10% of GDP in 2009/10 to 1.9% of GDP in 2018/19. Methodological changes and revisions in official data from 2000-2002 onwards including to student loans, public sector pensions and corporate tax data have led to an upward revision in the government deficit. Current EC projections point to a fiscal deficit of 2.2% in this fiscal year compared with 1.9% in the previous fiscal year, related to near term fiscal stimulus, as well as a multi-year settlement for the National Health Service. The structural deficit is broadly stable at around 2.4% of GDP according to EC calculations.

Long Public Debt Maturity Profile Mitigates against Debt Payment Risks

After a pronounced increase in the U.K.’s public debt ratio following the global financial crisis, this ratio is declining; it is expected to decline to 84.1% of GDP this fiscal year from 84.3% last year according to the EC. By comparison, the debt level is lower than the Euro area average of 85.1% at end-2018. DBRS Morningstar assesses the U.K’s commitment and capacity to meet its debt servicing needs as strong. Public borrowing is in British pounds sterling and the majority of gilt holders are domestic investors. DBRS Morningstar considers liquidity strength given sterling’s status as a reserve currency, the breadth and depth of the debt market, and the long maturity structure, warrants a positive qualitative adjustment in DBRS Morningstar’s “Debt and Liquidity” building block.

DBRS Morningstar Expects an Appropriate Monetary Policy Response to Economic and Inflation Conditions

The U.K. enjoys a high degree of monetary policy flexibility, owing to a responsive central bank and sterling’s status as a reserve currency. The Bank of England (BoE) took important measures to address financial volatility that occurred in the aftermath of the U.K. vote to leave the EU and, in August 2016, reduced Bank Rate to 0.25%. It has conducted loose monetary policy for many years, only returning the Bank Rate to the pre-August 2016 level of 0.5% in November 2017 and again increasing the rate to 0.75% in August 2018, given the strong labour market and credit growth. Inflation peaked at 3.1% in November 2017 and was 1.5% in October 2019. Financial stability risks include high household debt at 85.4% of GDP and 130.3% of household disposable income (end-2018). The process of leaving the EU poses another key risk to financial stability should there yet be an adverse outcome.

External Balances Are Manageable

The current account deficit has been shrinking. It was down to 3.5% of GDP in 2017 from 5.2% in 2016. The EC forecasts 4.3% this year and next year. The U.K. finances the current account deficit mainly through portfolio investment, and the net external liability position is moderate, at just 10.6% of GDP in December 2018. In the longer term, the impact of the U.K.’s exit from the EU on the external accounts is highly uncertain.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.

http://www.dbrs.com/research/354629

Notes:

All figures are in GBP unless otherwise noted. Public finance statistics reported on a general government basis unless specified. General government gross debt is calculated on a Maastricht basis. Fiscal figures as at end of fiscal year. General Government Gross Debt is calculated on a Maastricht basis.

The principal methodology is the Global Methodology for Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.