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 Stable trends.

The Stable trends reflect DBRS’s assessment that the challenges faced by the UK are manageable and are being addressed proactively. The trends could change to Negative if adverse shocks stemming from either the external sector or the private sector were to significantly slow the economic recovery, adversely affecting the public finances or the banking sector. The trends could also face downward pressure if government policies failed to stabilise the UK's debt burden during the multi-year fiscal adjustment. Following the U.K. referendum on European Union (EU) membership, a withdrawal from the EU that were to result in an unfavourable position for the UK in terms of trade and the investment environment as well as the uncertainty associated with the negotiation of a new arrangement between the UK and the EU could put pressure on the ratings. Moreover, the rating could also come under pressure if a significant degree of uncertainty ahead of the referendum, were to affect investment decisions and the growth outlook in the UK.

The ratings are underpinned by the country’s large, diversified and open economy, its resilient labour market as well as its flexible fiscal and monetary policy framework, coupled with its credible commitment to implementing 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 ratings.

After growing strongly by 3.0% in 2014, the UK’s economic activity is expected to ease with GDP growing at 2.5% in 2015 and 2.4% in 2016. Growth remains predominantly led by private consumption, supported by low borrowing costs, rising employment and household disposable income. In addition, the UK’s labour market has performed particularly well with the unemployment rate falling to 5.5% during Q1 2015, its lowest level in six years. The improvement in the labour market and a gradual pickup in productivity is expected to support growth in real wages and underpin consumption; however, there is a risk that productivity stays at current low levels, which would dampen wage growth.

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 (Maastricht Treaty definition) has narrowed to 5.1% of GDP in 2014-2015 from 10.2% in 2009-2010. DBRS expects the strong economic recovery to support the newly elected government’s fiscal consolidation plan to eliminate the current structural deficit by 2019-2020 and to ensure that public-sector net debt continues to fall as a share of GDP by 2015-2016. The government’s post-election Budget aims to deliver approximately the same fiscal tightening over the next five years (around 5% of GDP) as the pre-election Budget, but spread over a longer period of four years. The composition of the consolidation is set to broaden to include tax increases in addition to sizable welfare tightening and three years of higher borrowing.

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 debt to have peaked this year at 88.5% of GDP in 2014-2015 and to gradually decline thereafter reaching 68.5% in 2020-2021. A high level of debt will continue to call for additional fiscal consolidation over the medium term. The 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 following the intensification of the Greek crisis could lead to potential 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, which could 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 sizable current account deficit of 5.9% of GDP in 2014, up from 3.6% in 2012. The high deficit reflects the deteriorating income balance caused by the decline in earnings from overseas investment, especially from the eurozone. The risks associated with the large deficit are mitigated by the currency composition and long-term nature of the capital flows that are funding it, and the fact that the deficit is not combined with a rapid growth of domestic credit.

The outcome of a referendum on the UK’s membership in the EU, expected to take place by the end of 2017, could have wider implications for the UK’s sovereign rating. While the timing and outcome of the referendum remain uncertain, DBRS believes that the outcome will largely depend on the concessions achieved by the UK during the negotiations of the terms of the UK’s membership that are due to begin in Autumn this year. With the UK importing from the EU more than it exports and given the UK’s important role in the EU, in terms of the size of its economy (14% of EU GDP) and its contribution to the EU budget, DBRS expects the UK and the EU to agree on important concessions during the negotiation process. However, unsuccessful negotiations and an unfavourable new arrangement for the UK after the referendum would adversely affect business investment and growth prospects with potentially negative implications for DBRS’s sovereign ratings on the UK.

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: 16 January 2015

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