December 9, 2016 / 9:10 PM / 8 months ago

Fitch Affirms United Kingdom at 'AA'; Outlook Negative

(The following statement was released by the rating agency) LONDON, December 09 (Fitch) Fitch Ratings has affirmed the UK's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'AA'. The Outlooks are Negative. The issue ratings on the UK's long-term foreign and local currency bonds have also been affirmed at 'AA'. The Country Ceiling has been affirmed at 'AAA' and the Short-Term Foreign Currency and Local Currency IDRs at 'F1+'. The short-term bonds have also been affirmed at 'F1+'. KEY RATING DRIVERS The UK's ratings balance a high-income, diversified and advanced economy against comparatively high public sector indebtedness. Deep capital markets and sterling's international reserve currency status and high governance and human development indicators further support the ratings. At the same time, the referendum vote to leave the European Union has ushered in a period of heightened political, institutional, and economic uncertainty. Fitch recognises that there is a wide range of possible outcomes concerning the negotiations over Brexit and future institutional and trade relations between the UK and the EU. Given this uncertainty, the UK's ratings are not predicated on any particular base case. Nevertheless, we expect the UK to invoke Article 50 (of the Lisbon Treaty) by end-March 2017, implying that the UK would leave the EU two years later. Based on statements by the Prime Minister at the Conservative party conference, Fitch believes the UK government will seek to control immigration from the EU and end the jurisdiction of European Court of Justice. In our opinion, and based on the stated position and interests of the EU, this would make it unlikely that the UK remains a member of the European Single Market after leaving the EU. As well as the outcome and details of the Brexit agreement, a key uncertainty is whether it will include a transition arrangement that would provide some stability regarding trading arrangements ahead of the negotiations of a potential future free trade agreement between the UK and the EU. There has not been an abrupt slowdown in economic activity around and after the EU referendum. Real GDP rose by 0.7% qoq in 2Q16, and initial estimates point to 0.5% growth in 3Q16. Confidence indicators dipped after the referendum, but have recovered since. The resilience of business and consumer confidence since the referendum may have been supported by the Bank of England's decision to ease monetary policy in August. Nevertheless, Fitch assumes that private-sector investment growth will decline in 2017 as firms delay capital spending commitments in the face of the uncertainties about future trading arrangements with the EU and the regulatory environment. We expect private consumption growth to slow down, as higher inflation - from lower sterling and higher import prices - erodes real income growth. Net exports will support growth. Export growth will slow down over the next two years, but this will be more than offset by falling imports. We forecast GDP growth for this year to be 2%, followed by 1.2% and 1.0% in 2017 and 2018. We have revised up our projections for GDP growth from our first post-referendum forecast (by 0.3pps this year and next, and 0.1pp in 2018). We expect consumer price inflation to rise from 0.7% this year to 2.2% in 2017 and 2.7% in 2018. The improvement in net exports will also contribute to a narrowing in the current account deficit. This reached a record 5.4% of GDP in 2015. In addition to a lower trade deficit, we anticipate that the factors that have pushed up on the income account in recent years will unwind to some extent. We expect the deficit to average 4.9% of GDP this year, before falling back to 3.5% of GDP by 2018. The Chancellor of the Exchequer presented in the Autumn Statement the first set of official macroeconomic and public finance projections since the EU referendum. These assume GDP growth will be cumulatively 1.4 percentage points lower over its forecast period to 2021; and that potential growth in the UK economy will be due to lower productivity. The government has introduced minor discretionary budgetary easing measures, totalling GBP26bn (around 1.4% of forecast 2016 GDP) over this and the next four financial years to FY2020/21. The main discretionary policy change was the allocation of GBP16.7bn for extra capital expenditure. Official forecasts assume that the public sector to remain in deficit over at least the next five financial years, and that borrowing will be around GBP120bn higher over the five financial years to FY20/21compared to pre-referendum forecasts. Consistent with the new official projections, the government announced that it was abandoning its target for ensuring an overall surplus in FY19/20, indicating that it aims to achieve a budget balance as early as possible in the next parliament. The government's new fiscal objectives are for cyclically-adjusted public sector net borrowing to be under 2% of GDP, and for public sector indebtedness to be falling, by FY20/21. There is also a supplementary target for welfare spending. We expect the general government deficit to be 3.6% of GDP this year. Given our more cautious macroeconomic projections compared with official forecasts, we expect a more moderate decline in the deficit over the next two years. We expect the deficit to be 3.3% in 2017 and 3% in 2018. This would be consistent with general government debt (on international definitions) rising from 89.1% of GDP at end-2015 to 91.5% by end-2018. UK banks remain well-capitalised and prepared to withstand potentially challenging market volatility. Major UK banks had an aggregate common equity Tier 1 capital ratio of 13.5% in September. In July, the Bank of England reduced the counter-cyclical capital buffer rate on UK banks' exposures from 0.5% to zero, and has indicated that it expects to maintain this rate at least until mid-2017. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns the UK a score equivalent to a rating of 'AA' on the Long-Term FC IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES Future developments that could result, individually or collectively, in a downgrade are: -Evidence that the Brexit vote is having a significant negative impact on the UK economy -Worsened public finance developments leading to a continued rise in the government debt/GDP ratio -Political shocks that impede a clear determination of the UK's future relationship with the EU or undermines the economic policy framework or economic performance -An outcome of the negotiation on Brexit and future trade arrangements with the EU that adversely affects UK economic growth prospects, public finances or the UK's political integrity Future developments that could, individually or collectively, result in the Outlook being revised to Stable include: -Evidence that the UK's short- and medium-term growth prospects prove resilient to the shock of the Brexit vote -Further reductions in the budget deficit, leading to a stabilisation in the government debt to GDP ratio -An outcome of the negotiations on Brexit and future trade negotiations with the EU that supports UK growth prospects and public finances. KEY ASSUMPTIONS In our public debt sensitivity scenario, we project that the government debt to GDP ratio peaks at 91.5% in 2018 and falls to 82% by 2025. This scenario assumes, on average, real GDP growth of 1.6%, annual GDP deflator inflation of 1.7%, an average effective interest rate of 2.4%, and an average primary balance of -0.2% of GDP. Contact: Primary Analyst Alex Muscatelli Director +44 20 3530 1695 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst James McCormack Managing Director +44 20 3530 1286 Committee Chairperson Ed Parker Managing Director +44 20 3530 1176 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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