DBRS Confirms United Kingdom’s AAA Ratings with Stable Trend

DBRS Ratings Limited (DBRS) has today confirmed the AAA ratings on the foreign and local currency securities of the United Kingdom of Great Britain and Northern Ireland (the U.K.). The ratings are underpinned by the size, openness and diversity of the British economy, its fiscal and monetary policy flexibility as well as flexible product and labour markets. In addition, the U.K. benefits from having deep, efficient domestic capital markets, a long average debt maturity and from the Sterling’s status as a secondary reserve currency. DBRS has also confirmed the short-term foreign and local currency ratings at R-1 (high). All of the ratings have a Stable trend.

The legacy of the 2008-2009 global financial crisis, which resulted in a large structural deficit and a high debt burden, continues to weigh on the country’s credit profile. The Stable rating trend is mainly supported by the government’s pledge to implement its far-ranging fiscal adjustment and the accommodative monetary policy stance pursued by the Bank of England. DBRS notes, however, that the sizeable fiscal austerity efforts introduced by the government since 2010 adversely weigh on the growth outlook. Prospects for the U.K. economy thus remain fragile due to the combination of fiscal consolidation, private sector deleveraging and poor credit availability, further exacerbated by subdued economic growth prospects in the Euro zone.

DBRS further acknowledges that the government’s fiscal consolidation plans have come under pressure due to weaker than expected growth, as this has resulted in lower tax returns and higher public sector net borrowing. The independent Office for Budget Responsibility (OBR) expects the government to meet its target of eliminating the underlying structural deficit by 2016-17. The government is however unlikely to meet its supplementary target of achieving a declining public sector net debt as a share of GDP in 2015-16. According to the Maastricht definition, the deficit is estimated to be 5.2% of GDP in 2012-13, down from 7.7% in 2011-12. General government gross debt is expected to reach 90.3% of GDP in 2012-13, and to peak at approximately 97.4% of GDP in 2015-16, before gradually declining thereafter. DBRS notes, however, that the long average maturity of the public debt stock, at more than 14 years in 2012, is by far the longest among advanced economies. This limits refinancing risk and reduces the sensitivity of the consolidation plan to interest rate shocks.

Following the revised economic projections, the OBR expects the economy to contract by -0.1% in 2012 and to grow by 1.2% in 2013, compared to a previous growth forecast of 0.8% and 2%, respectively. Output is not expected to exceed its 2007 pre-crisis peak until the end of 2014 as the rebalancing of the economy away from private consumption and government spending towards business investment and trade proves to be slower than anticipated. Fixed investment is forecast to increase by only 1% year-over-year in 2012, after contracting 2.4% in 2011. Exports have also been weaker than anticipated, leading to a negative contribution from net trade to GDP growth of 0.6 percentage points, and to a widening of the current account deficit to 4% of GDP in 2012.

In addition to the weak domestic environment, the evolution of the Euro zone debt crisis continues to weigh on the British economy through a range of trade, confidence and financial channels. DBRS believes that although the easing of financial market tensions in the Euro zone in recent months has diminished the risks, tensions are on-going and could intensify. DBRS further acknowledges that although the exposure to the private non-financial sector in some Euro zone economies remains significant, U.K. banks have been improving their capital ratios and are only marginally exposed to the weaker Euro zone sovereigns.

In DBRS’s view, the revisions to the pace of the fiscal consolidation, as a result of the weaker than expected economy, are likely to reduce the pressure on domestic demand by spreading the adjustment over a longer time horizon. Nevertheless, there are still potential implementation risks to consolidation, as only 52% of the planned tightening is now scheduled to occur before the 2015 election, with three additional years of tightening due to take place beyond it. Despite this, DBRS believes that the government's commitment to its long term fiscal stance continues to provide an anchor for market expectations, resulting in low government bond yields.

While the deteriorating growth outlook for the U.K. is affecting the credit metrics of the country, the economy is showing resilience as the unemployment rate declined to 7.8% in the second half of 2012, down from its peak of 8.3% in late 2011. DBRS notes that favourable labour market dynamics have also provided some degree of support to tax revenues and social security spending. In addition, DBRS expects the Bank of England’s accommodative policy stance to continue in 2013, providing relief to households and businesses, as low interest rates help to keep private sector debt-servicing costs low and the currency competitive.

Going forward, the evolution of the U.K.’s ratings ultimately depends on the government’s long-term commitment to fiscal consolidation in order to achieve debt sustainability. DBRS may change the Stable trend to Negative in case of: (1) a material downward revision of the U.K.'s medium-term growth potential causing the debt metrics to enter an unsustainable path; (2) significant fiscal slippage resulting in further delays in the implementation of fiscal consolidation measures; or (3) a sharp rise in funding costs, driven by an external shock or deterioration in market confidence.

Notes:
The principal applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include the HM Treasury, the Bank of England, the Office for Budget Responsibility (OBR), the Debt Management Office (DMO), the Office for National Statistics (ONS), Eurostat, the IMF, the World Bank.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

Ratings assigned by DBRS Ratings Limited are subject to EU regulation only.

Lead Analyst: Giacomo Barisone
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 19 July 2010
Most Recent Rating Update: 16 November 2012

For additional information on this rating please refer to the linking document under Related Research.