DBRS Confirms 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 sector or the private sector were to significantly slow the economic recovery, adversely impacting the public finances or the banking sector. The trend could also face downward pressure if government policies failed to stabilise the UK's debt burden during the multi-year fiscal adjustment.

The ratings 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 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 accelerated in 2014 with GDP growing by an estimated 3%. Supported by 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, and is more recently showing signs of handing over to business investment. In addition, the UK’s labour market has performed particularly well with unemployment falling at 6%, its lowest level in six years. Growth is projected to ease to 2.5% in 2015 supported by an upturn in gross fixed investment and a gradual recovery in productivity, which should support growth in real wages and underpin consumption.

To date, the UK has made material progress with fiscal consolidation. According to the independent Office for Budget Responsibility (OBR), the general government budget deficit has narrowed to 5.3% of GDP in 2014-15 from 10.2% in 2009-10. DBRS expects the economic recovery to support the government's fiscal consolidation efforts over the medium term in line with the OBR’s expectation that the general government budget deficit will be eliminated by 2018-19. However, it cautions that the outlook for public finances remains dependent on large as yet unspecified spending cuts to be implemented after the general election scheduled for May 7 this year.

The 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 further 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.

Notwithstanding the progress made on fiscal consolidation and in spite of a stronger than expected economic performance, general government gross debt, although sustainable remains high. The OBR projects it will reach 88.0% of GDP in 2014-15 and to peak at approximately 90% of GDP in 2016-17 before gradually declining thereafter. A high level of debt will continue to call for additional fiscal consolidation over the medium term. The long average maturity of the public debt stock, at almost 15 years in December 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.

Moreover in the longer term additional challenges confront the British economy. 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 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.

Other challenges facing the country relate to the still sizeable current account deficit of 5.3% of GDP in 2014Q3, up from 3.6% in 2012Q3. The high 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, albeit growing, exposure to faster growing emerging markets, and an unfavourable export product mix.

Finally, DBRS believes that political uncertainties are likely to increase over the near term, with the UK general election approaching in May 2015, and a possible referendum on EU membership by 2017. The decline in support for the three main parties, and the rise of smaller parties, leaves the outcome of the general election uncertain and likely to result in a hung parliament with no single party having a majority. A period of moderate instability seems likely, immediately following the election if cross-party negotiations are required before a government can be formed and a set of policy priorities agreed upon. However, DBRS does not expect substantial changes in the fiscal policy stance as all major parties are committed to the multi-year fiscal consolidation program. Over the longer term, in the event of a vote in favour of leaving the EU, DBRS believes this event could weaken the UK’s growth prospects, at least over the medium term, as business sentiment and investment would likely be adversely impacted putting downward pressure on trade, productivity and growth.

Notes:
All figures are in pounds 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 HM or Her Majesty’s Treasury, Bank of England, Debt Management Office, Office for National Statistics, Office for Budget Responsibility, European Commission, European Central Bank, IMF, OECD, BIS, 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: 18 July 2014

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