DBRS Confirms the United Kingdom at AAA, Stable Trend

DBRS Ratings GmbH (DBRS) 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 confirmed the Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

Brexit continues to be the dominant feature of the U.K.’s political economy. Risks stemming from Brexit remain significant and even three years on from the 2016 Brexit vote, visibility around the U.K.’s future relationship with the EU is limited. While a clear majority within the U.K. parliament has expressed opposition to a no-deal Brexit, the resignation of Theresa May and the upcoming Conservative Party leadership contest elevates the rhetoric around a no deal scenario, and by extension the possibility. However, DBRS remains of the view that the likelihood of a no deal Brexit materializing is low. DBRS acknowledges some degree of event risk associated with an accidental crash out of the EU if no way forward is evident by late October, and EU institutions do not agree to an additional Brexit extension.

Notwithstanding the general uncertainty, DBRS expects a broadly appropriate and timely policy response from the U.K. and the EU to any resulting economic or financial turmoil. Furthermore, key macroeconomic indicators thus far suggest some resilience and the costs of the slowdown have been manageable. GDP growth expectations are less favourable, but the unemployment rate of 3.8% is at its lowest level in over forty years. The latest fiscal forecasts point to a small downward revision to borrowing this year and according to the European Commission (EC) the public debt ratio is expected to decline to 85.1% of GDP this year and to 84.2% next year.

The U.K.’s AAA ratings reflect the size and resilience of the economy and the shock-absorbing benefits of its own monetary policy. 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. Bond yields have tightened when Brexit outcomes have appeared least certain. The U.K.’s maturity structure of public debt at around 15 years is the longest average maturity in the G7. DBRS does not expect key rating features to change, regardless of the outcome of Brexit. These factors include Central Bank independence, a sound financial supervisory structure, and statutory fiscal rules that match the discipline of (EU) frameworks.

RATING DRIVERS

The U.K.’s ratings are well placed in the AAA rating category. The 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 such that could occur in the context of a no deal Brexit outcome; (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

The Delivery of Brexit has been Postponed

The Withdrawal Agreement between the EU and the U.K. has not been approved by the U.K. parliament. The part of the agreement that aims to circumvent a hard border between the Republic of Ireland and Northern Ireland, by requiring the U.K. to remain in a ‘customs territory’ with the EU until a permanent solution is found, has predictably proven to be a key obstacle to ratification.

DBRS maintains the view that decisions on the customs union that potentially affect the border between the Republic of Ireland and Northern Ireland are among the most challenging in delivering Brexit. Significant uncertainty remains over different regulatory and customs regimes between Northern Ireland and the mainland, and how this might impact the U.K. A no deal Brexit in particular could ultimately jeopardize the cohesion and resilience of the United Kingdom.

The extension of the Brexit timeline until 31st October 2019 highlights deep divisions within the political parties. With the current U.K. parliament unable to agree on a way forward, a general election and/or a second Brexit referendum may be the only way to resolve the deadlock. It is still possible that Article 50 is unilaterally withdrawn or that it could be again extended following agreement to do so by the EU-27. Extension is likely to depend on whether the EU feels more time is necessary to help resolve the impasse, particularly, either to accommodate an election or a referendum.

DBRS continues to monitor the extent of parliamentary focus on Brexit and the impact on the economy of the reduced focus on other priorities such as general healthcare, care for the elderly, welfare reform and productivity improvements.

The Economy has Slowed, but the U.K. Unemployment Rate is Historically 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 is weaker. The Office for Budget Responsibility (OBR) forecasts economic growth at 1.2% this year, compared with 1.4% in 2018 and 1.8% in 2017. The OBR forecasts 1.4% GDP growth in 2020 and average annual growth of 1.6% in 2021-23. There are downside growth risks, however, stemming from domestic and external factors, and DBRS acknowledges the risk of a technical recession. At the moment, employment continues to grow and the unemployment rate at 3.8% is the lowest rate since 1974. The employment rate is at a joint record of 76.1% 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.

Continued Fiscal Consolidation is Expected to Support a Slow Reduction in the Debt Ratio

The U.K.’s fiscal framework is sound and 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 1.1% of GDP in 2018/19. Recently, tax revenues have surprised to the upside despite the weaker economy, reflecting stronger employment growth. In addition, debt interest expenditures have been lower than expected. Current official projections point to a fiscal deficit of just 1.3% in this fiscal year and 0.9% next year. These projections include near term fiscal stimulus, as well as a new multi-year settlement for the National Health Service.

The fiscal mandate of achieving a structural deficit below 2% of GDP in 2020-2021 is expected to be met with increased fiscal headroom relative to that published by the OBR in October. The supplementary target of public-sector net debt as a share of GDP falling in 2020-2021 is also met. It falls by 3.2% of GDP unchanged from the previous forecast, with 2.2 percentage points of the decline related to the ending of the Bank of England’s Term Funding Scheme.

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 85.1% of GDP this year and to 84.2% next year. Nevertheless, the debt level remains high and somewhat reduces the U.K.’s scope for fiscal flexibility in times of crisis, but for comparison it closely matches the Euro area average of 86.1% (end-2018). DBRS assesses the country’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 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 is currently 2.1%. Additional rate increases are not expected in the near term, and the post-Brexit interest rate path is yet unknown, but expected to be appropriate. Financial stability risks include high household debt at 90.4% of GDP and 133.3% of household disposable income (end-2018), as well as housing price growth, although this has recently decelerated. The process of leaving the EU poses another key risk to financial stability should there be an adverse outcome. However, the U.K. banking system has improved its results (https://www.dbrs.com/research/340942/).

External Balances Are Manageable

The current account deficit has been shrinking. It was down to 3.9% of GDP in 2018 from 5.2% in 2016. The IMF forecast is for 4.2% this year and 4.0% next year. Latest data for the fourth quarter of 2018 show a widening in the deficit related to worsening deficits on the primary income account and the trade account. However, the United Kingdom finances the current account deficit mainly through portfolio investment, and the net external liability position is moderate, at just 6.7% 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.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA (high) range. The main points discussed during the Rating Committee include GDP performance, fiscal consolidation and potential Brexit impact.

KEY INDICATORS

Fiscal Balance (% GDP): -1.1 (2018); -1.3 (2019F); -0.9 (2020F)
Gross Debt (% GDP): 86.8 (2018); 85.1 (2019F); 84.2 (2020F)
Nominal GDP (GBP billions): 2,118 (2018); 2,185 (2019F); 2,258 (2020F)
GDP per Capita (GBP): 31,862 (2018); 32,678 (2019F); 33,576 (2020F)
Real GDP growth (%): 1.4 (2018); 1.2 (2019F); 1.4 (2020F)
Consumer Price Inflation (%): 2.5 (2018); 1.8 (2019F); 2.0 (2020F)
Domestic Credit (% GDP): 186.7 (2017); 186.0 (2018)
Current Account (% GDP): -3.9 (2018); -4.2 (2019F); -4.0 (2020F)
International Investment Position (% GDP): -8.1 (2017); -6.7 (2018)
Gross External Debt (% GDP): 312.2 (2017); 312.7 (2018)
Governance Indicator (percentile rank): 90.9 (2017)
Human Development Index: 0.92 (2017)

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. Fiscal Balance (ONS), Gross Debt (EC), Nominal GDP (EC), GDP per Capita (EC), Real GDP growth (OBR), Consumer Price Inflation (IMF), Domestic Credit (ONS), Current Account (IMF), International Investment Position (ONS), Gross External Debt (DNB/DSt). Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include UK Office for National Statistics, the Office of Budget Responsibility, HM Treasury, Debt Management Office, the Bank of England, International Monetary Fund, European Commission, Organization for Economic Co-operation and Development, United Nations Development Programme (UNDP), World Bank, Bloomberg L.P, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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.

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

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

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Nichola James, Senior Vice President, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Rating Committee Chair: Alan G. Reid, Global Managing Director, Global Financial Institutions Group and Sovereign Ratings

Initial Rating Date: July 19, 2010
Last Rating Date: December 14, 2018

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DBRS amended this PR on 4 July 2019 to correct a legal entity typo in the disclosure section.