DBRS Confirms the United Kingdom at AAA, with Stable trend

DBRS Ratings Limited (DBRS) has today confirmed the long-term foreign and local currency ratings of the United Kingdom of Great Britain and Northern Ireland (the UK) at AAA, and the short-term foreign and local currency ratings at R-1 (high). All ratings have a Stable trend.

The Stable trend reflects DBRS’s assessment that the challenges faced by the UK are manageable and are being addressed proactively. As a result, DBRS does not anticipate downward pressures on the rating. The trend could be changed to Negative if adverse shocks stemming from either the external or the private sector were to significantly slow the economic recovery, adversely impacting the public finances or the banking sector. The ratings would also face downward pressure if government policies failed to stabilise the UK's debt burden during the multi-year fiscal adjustment. A material weakening of the institutional environment, for example, in the event of a 'yes' vote in the Scottish referendum, or a vote in favour of leaving the EU leading to a high degree of uncertainty affecting business investment, consumption and the country’s public finances, could put pressure on the ratings.

The ratings on the UK are underpinned by the country’s large, diversified and open economy; its resilient labour market; and its flexible fiscal and monetary policy framework. This is coupled with its credible commitment to implement a far-ranging fiscal consolidation program. In addition, the UK benefits from a deep, efficient domestic capital markets, a long average debt maturity, and Sterling’s status as a secondary reserve currency. A strong institutional framework also supports the rating.

After gaining momentum through 2013, the UK economic recovery has accelerated into 2014 with GDP growth expected to reach 2.7% this year and 2.5% in 2015. Supported by continued monetary stimulus, growth is being driven by private consumption, a strong recovery in the housing market, a revival in business investment, and a more gradual pace of household and public sector deleveraging. The recovery has been predominantly demand led, driven by stronger household consumption and housing investment, is more recently showing signs of handing over to business investment. Growth in 2015 is projected to broaden further mainly supported by an upturn in gross fixed investment and a gradual recovery in productivity.

DBRS expects the strong economic recovery to support the government's fiscal consolidation efforts over the medium term, but cautions that the outlook for public finances remains dependent on as yet unspecified spending cuts to be implemented after the 2015 election. According to the independent Office for Budget Responsibility (OBR), the budget deficit is expected to narrow to 5% of GDP in 2014-15 from 11.4% in 2009-10. General government gross debt remains high and the OBR project it to reach 91.8% of GDP in 2014-15 and to peak at approximately 93.1% of GDP in 2015-16 before gradually declining thereafter. General government debt is likely to remain at high though sustainable levels over the medium-term. The long average maturity of the public debt stock, at almost 15 years in May 2014, is by far the longest among advanced economies. This limits refinancing risk and reduces the sensitivity of the consolidation plan to interest rate shocks.

The gradual improvements in the UK banking sector's capital and liquidity position have further reduced contingent liabilities. The financial sector is also increasingly capable to support the economic recovery by transmitting easy monetary conditions to borrowers. DBRS expects the Bank of England's highly accommodative policy stance to maintain private-sector debt-servicing costs moderate and support the recovery. Financial sector policies aimed at improving the oversight framework and increasing the capacity to deal with systemically important financial institutions should help reduce systemic risks.

Several challenges confront the British economy in the longer term. Despite recent improvements, growth in the Euro area is likely to be moderate, and the re-emergence of market tensions cannot be ruled out, with the potential for continued spillovers via the trade and financial channels, higher funding costs, and reduced confidence. Were such uncertainty to persist over the medium-term, investment would likely be subdued and dampen productivity growth. On the domestic front, the continued need for deleveraging in the public sector and a highly indebted household sector could pose further headwinds to growth over the medium term.

In addition, recent double digit increases in house prices, in particular in London and its surroundings, could lead to excessive rise in household indebtedness if supported by unsustainable borrowing practices. If unrestrained over the long term, this would increase macroeconomic risks posing direct risks to the resilience of the UK banking system with potential negative repercussions on the UK’s fiscal position.

Other challenges facing the country relate to the still sizeable current account deficit of 4.4% of GDP in 2014Q1, up from 3.6% in 2012Q3. The high current account deficit primarily reflects the deteriorating income balance due to the decline in earnings from overseas investment, the UK’s structural dependence on imports, and export underperformance driven by the UK’s relatively high exposure to low-growth advanced economies, its low exposure to faster growing emerging markets, and unfavourable export product mix.

Finally, while economic uncertainties are waning, DBRS believes that political uncertainties are likely to increase over the medium term, with Scotland’s independence referendum in 2014, the UK general election in 2015, and possible referendum on EU membership by 2017. DBRS believes these events could create uncertainties over the UK’s medium-term fiscal outlook, potentially adversely affecting business confidence and leading to changes in the UK’s political structure.

Notes:
All figures are in pound sterling (GBP) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS 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.

These can be found on www.dbrs.com at:
http://www.dbrs.com/about/methodologies

The sources of information used for this rating include IMF, OECD, BIS, European Commission, Bank of England, European Central Bank, Office for Budget Responsibility, Debt Management Office, Her Majesty Treasury, Office for National Statistics, Bloomberg, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.

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

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period, while reviews are generally resolved within 90 days. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

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

Lead Analyst: Giacomo Barisone
Rating Committee Chair: Roger Lister
Initial Rating Date: 19 July 2010
Most Recent Rating Update: 14 February 2014

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