Morningstar DBRS Confirms the United Kingdom at AA, Stable Trend

DBRS, Inc. (Morningstar DBRS) confirmed the United Kingdom of Great Britain and Northern Ireland's (the United Kingdom or the UK) Long-Term Foreign and Local Currency - Issuer Ratings at AA. At the same time, Morningstar DBRS confirmed the Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects Morningstar DBRS' view that risks to the credit ratings are balanced. The UK economic recovery is expected to continue this year, though momentum is limited due to ongoing global trade uncertainty and the lagged effect of monetary easing. However, growth is anticipated to pick up next year, supported by moderating inflation and improving financial conditions. Downside risks to the growth outlook include heightened trade policy uncertainty weighing on exports and investment, and weak business sentiment amid a higher tax burden. The IMF forecasts GDP growth of 1.1% in 2025 and 1.4% in 2026. Headline inflation has declined, but services inflation remains elevated. The Bank of England (BoE) has reduced its policy rate to 4.25%, a cumulative 100 bps cut since August 2024, and is expected to continue its gradual approach to easing until inflationary pressures subside further. The pace of fiscal consolidation is slowing, with the general government debt ratio projected to rise to 105.9% of GDP in FY2029-30. Financial vulnerabilities appear contained, limiting risks to financial stability.

The credit rating for the UK is supported by its large, diverse, and wealthy economy, very strong governance indicators, including rule of law and government effectiveness, its financing flexibility, and its robust and credible monetary policy. The Bank of England oversees a reserve currency that supports the UK's substantial capacity for external adjustment. The UK's deep and liquid capital markets, alongside the reserve currency status of the pound sterling, supports the country's significant degree of financing flexibility. However, the UK also faces credit challenges stemming from weak public sector finances¿a persistent fiscal deficit and high government debt¿low economic growth, and external imbalances, with a recurrent current account deficit.

CREDIT RATING DRIVERS
An upgrade could occur if (1) the public debt ratio returns to a sustained downward path, or (2) the UK's growth prospects improve, with higher and sustained productivity growth. A downgrade could occur if (1) a severe economic or financial shock has a material adverse impact on the economy and fiscal accounts, damaging the UK's financing flexibility, or (2) the likelihood of a break-up of the UK materially increases.

CREDIT RATING RATIONALE

Slower Path to Fiscal Consolidation, But Further Deficit Reduction Anticipated

The pace of the UK's fiscal consolidation is slowing. For FY2024-25, the government estimates the general government deficit at GBP 170.5 billion, about GBP 12.8 billion higher than the Office for Budget Responsibility's (OBR) March forecast, which was about 5.5% of GDP. The deficit reflects lower tax revenues, higher debt interest payments, and increased inflation-related costs like higher public sector wages and benefits. The OBR forecasts the deficit to narrow to 4.3% in FY2025-26, and then gradually decline to 2.8% in FY2029-30, a slower path than previously anticipated. The fiscal improvement over the forecast period reflects higher projected government revenues¿largely driven by bracket creep and the rise in employer National Insurance contributions (NIC)¿along with reductions in government spending. Some tighter fiscal measures introduced in the Spring 2025 Statement include welfare benefits and departmental spending cuts, a reduction in the civil service force, and improved tax compliance measures. The slower pace of fiscal consolidation will result in the general government debt ratio gradually rising from 102.0% of GDP in FY2024-25 to 105.9% in FY2029-30.

The government announced changes to its fiscal rules in the Autumn 2024 Budget. Under the new fiscal mandate, the government targets a current budget surplus and a reduction in public sector net financial liabilities (PSNFL) as a share of GDP by FY2029-30. The shift to a three-year, rather than five-year timeframe, reinforces its commitment to near-term fiscal consolidation. Given the policy measures set out in the Spring 2025 Statement, the current balance for FY2029-30 will remain unchanged at GBP 9.9 billion, maintaining the government's fiscal rule. However, the narrow fiscal headroom provides limited shock absorption, increasing the risk of fiscal slippage in the absence of policy adjustments. In particular, NATO-qualifying defence spending is set to rise to 2.5% of GDP by April 2027, with the potential for further increases, which may add to fiscal pressures.

The UK's debt profile remains broadly favourable, despite higher interest costs. The long average maturity of debt, at just above 14 years, partly limits the impact from an increase in interest rates. The interest costs-to-GDP ratio has reduced slightly since rising significantly in 2022 but remains elevated relative to historic norms. The IMF projects interest costs to average 2.8% of GDP between 2025 to 2029, higher than the 1.7% average recorded in the decade to 2021. On the investor base, major gilt holders include domestic insurance and pension funds with 21% of gilts, the BoE with 24%, and overseas investors with 32%. Given the depth of the UK debt market and the sterling's status as a reserve currency, the UK enjoys a high degree of financing flexibility, which supports our one-category adjustment to the `Debt and Liquidity' building block assessment.

The UK Economic Recovery Continues, While Long-Term Challenges Persist

Following weak growth in 2023, the UK recorded a modest economic recovery in 2024, with 1.1% real GDP growth. Economic activity was supported by government spending and business investment. Growth is expected to remain modest this year, reflecting the delayed impact of recent rate cuts, a softening labor market, and weaker investment and export prospects amid global trade uncertainty. However, economic activity is expected to pick up next year as disinflation supports household incomes and monetary policy eases. In Morningstar DBRS' view, downside risks to the near-term economic outlook include an intensification of global trade and geopolitical tensions, a resurgence in inflation, tighter-for-longer financial conditions, or renewed financial market turmoil.

The UK economy has experienced low growth since the global financial crisis, which is largely due to lower productivity growth. From 2009 to 2024, the economy expanded by just 1.2% per year, well below the 2.9% average from 1993 to 2007. Brexit, the pandemic, and the energy price shock have weighed on business investment in recent years. Additionally, labour force growth has slowed, partly due to rising labour inactivity from long-term sickness, with Brexit also weighing on labour supply. In response, the Labour government has prioritized economic growth. The government has adopted measures to increase labour market participation, such as welfare system reforms, increases to childcare support, and improvements to the National Health Service (NHS). Additional growth initiatives include increased capital investment, regulatory reform, clean energy project development, and the integration of AI. Moreover, the government has introduced planning reforms in its National Planning and Policy Framework (NPPF) which aim to support housing development. The OBR projects these planning reforms to add 0.2% to real GDP by FY2029-30 and add over 0.4% by FY2034-35. The effectiveness of these policy measures in improving growth prospects is yet to be proved.

Gradual Monetary Policy Easing Supports Housing Recovery, But Inflation Pressures Linger In Near Term

Inflation is moderating but remains elevated due to lingering underlying price pressures. Headline inflation has substantially declined from its 11.1% (y/y) peak in October 2022 to 2.6% in March 2025, under the weight of restrictive monetary policy and lower energy and goods price growth. Core and services inflation remain relatively high, at 3.4% and 4.7%, respectively in March, but are projected to gradually decline as wage growth slows. The BoE has lowered its policy rate by 100 bps cumulatively since August 2024, but monetary policy is still restrictive at 4.25%. The BoE expects inflation to rise to about 3.5% in the third quarter of 2025 due to higher global energy prices and regulated price increases, and then subsequently fall towards its 2% target in early 2027. Despite the expected near-term inflation uptick, subdued demand amid global uncertainties may support further policy easing. At the same time, quantitative tightening is progressing.

Risks to financial stability appear contained. Household debt remains high at 118.1% of disposable income in the fourth quarter of 2024, which could pose a risk if unemployment rises sharply. The share of highly indebted households remains relatively low, but mortgage payments are expected to rise for around half of borrowers as low fixed-rate mortgages expire. Elevated borrowing costs also dampened housing demand, causing house prices to fall about 5.1% y/y from the peak in the third quarter of 2022 to the fourth quarter of 2023. However, house prices have been modestly recovering since early 2024 amid easing interest rates and supportive economic conditions, like a relatively strong labor market. We make a one-category adjustment to the `Monetary Policy and Financial Stability' building block assessment to reflect that while interest rate pressures are easing, risks persist for households and businesses that have yet to fully price in the impact of higher borrowing costs.

The UK's banking system remains resilient, despite the challenges posed by the adverse macroeconomic environment. The banking system is well-capitalised and banks maintain strong liquidity positions. Even though elevated interest rates continue to put pressure on households and businesses, asset quality for major UK banks remains strong. In other parts of the UK financial system, a rapid increase in gilt yields in September 2022 affected part of the UK pension fund market, particularly liability-driven investment funds. Since then, their shock absorption capacity has been reinforced with the adoption of new standards.

The UK's External Accounts Slightly Improved in 2024

The UK has recorded persistent current account deficits for decades, mainly reflecting a negative trade and income balance. The UK's goods deficit is partly offset by its large services surplus, which averaged about 6% of GDP over the past decade. Since 2021, the current account deficit widened primarily as a result of rising energy and food prices and increased income payments to foreign investors. In 2024, the current account deficit improved slightly to 3.4% of GDP from 3.5% of GDP in 2023. Morningstar DBRS expects the current account deficit to widen modestly in the near term, partly due to softer global demand amid heightened trade uncertainty, before narrowing thereafter. The UK mainly finances the current account deficit through net financial inflows. The UK's net external liability position has also improved to 10% of GDP in 2024 from 14% in 2023.

The Labour Government's Majority Supports Legislative Implementation

The UK benefits from solid political institutions, with strong governance indicators as reflected in the high scores from the Worldwide Governance Indicators, lessening some of the risks from potential domestic political tensions and regional divisions that have increased in recent years. Earlier challenges have eased, but the long-term cohesion of the four-nation UK remains an ongoing consideration. The political environment is characterized by strong rule of law, low levels of corruption, and a sound regulatory environment. Led by Prime Minister Keir Starmer, the ruling Labour Party holds a strong majority in the House of Commons (403 of 650 seats). The Labour government was elected on a mandate to revive economic growth, strengthen energy security, meet climate targets, and improve public finances. In Morningstar DBRS' view, the government's large majority in parliament allows for a more decisive implementation of policies. The Labour Party's economic plan is subject to execution risks, and even if fully implemented, the results will take time to materialise.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings at (August 13, 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at https://dbrs.morningstar.com/research/454226.

Notes:
All figures are in British pound sterling unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (July 15, 2024) https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

The primary sources of information used for these credit ratings include HM Treasury (Spring Statement 2025, Autumn Budget 2024), Office of Budget Responsibility (Economic and Fiscal Outlook March 2025, Fiscal Risks and Sustainability Report September 2024), UK Debt Management Office (Quarterly Review October-December 2024), Bank of England (Monetary Policy Report May 2025, Financial Stability Report November 2024), Office for National Statistics, Department for Energy Security and Net Zero, IMF, OECD, BIS, World Bank, and Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.

The credit rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS did not have access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

For more information on Morningstar DBRS' policy regarding the solicitation status of credit ratings, please refer to the Credit Ratings Global Policy, which can be found in the Morningstar DBRS Understanding Ratings section of the website: https://dbrs.morningstar.com/understanding-ratings

This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed credit ratings:

The last credit rating action on this issuer took place on November 15, 2024.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/454210.

Lead Analyst: Julia Specht, Assistant Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Global Sovereign Ratings
Initial Rating Date: July 19, 2010

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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