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Fitch Affirms United Kingdom at 'AA'; Outlook Negative
May 5, 2017 / 8:07 PM / 7 months ago

Fitch Affirms United Kingdom at 'AA'; Outlook Negative

(The following statement was released by the rating agency) LONDON, May 05 (Fitch) Fitch Ratings has affirmed the UK's Long-Term Foreign- and Local-Currency IDRs at 'AA'. The Outlooks are Negative. The Country Ceiling has been affirmed at 'AAA' and the Short-Term Foreign-Currency and Local-Currency IDRs at 'F1+'. The issue ratings on the UK's senior unsecured bonds and short-term debt have also been affirmed at 'AA' and 'F1+'. KEY RATING DRIVERS The UK's ratings balance a high-income, diversified and advanced economy against comparatively high public sector indebtedness. Sterling's reserve currency status and deep capital markets, together with high governance and human development indicators further support the ratings. The Negative Outlook reflects the heightened uncertainty following the referendum vote to leave the European Union in June last year. At the end of March, the UK government triggered Article 50 of the EU Treaty, which implies that the UK will very probably leave the EU by April 2019. Before then, the UK and the EU27 will have to negotiate a withdrawal agreement, and, at least in the intentions of the UK government, future trade relations. The UK government has ruled out in its guidelines for the Brexit process continued membership of the EU Single Market and the full EU Customs Union, while stating the objective of reaching a free trade agreement with the EU. The UK government also intends to end the European Court of Justice's jurisdiction in the UK, and controlling immigration from EU countries. Fitch believes the negotiation process over the withdrawal agreement and institutional and trade relations between the UK and the EU will be challenging and that there is a wide range of possible outcomes. These range from a full free trade agreement between the UK and the EU, possibly with a transitional agreement with continued preferential access to the EU Single Market, to a reversal to trading on WTO terms. This range implies uncertainty around the UK's medium- to long-term growth rate, trade openness, and productivity. Given this uncertainty, the UK's ratings are not predicated on any particular base case. In mid-April, Prime Minister Theresa May, after parliamentary approval, called a general election for 8 June, three years before the scheduled dissolution of the current parliament. Current opinion polls point to a victory for the governing Conservative Party, quite possibly with an enlarged majority. This suggests broad policy continuity, including in relation with the Brexit process. However, the eventual electoral outcome and its political and economic policy implications are inherently uncertain. The March budget did not include very substantial discretionary fiscal policy measures. Additional spending on social care and schools over the next three years was to be offset by changes in dividend taxation and social contributions for the self-employed. However, subsequent political opposition to the latter brought about a reversal of this rise. This reversal does not materially impact the outlook for the public finances, given its small size. At the same time, it points to a degree of rigidity in fiscal policy. The general government deficit fell sharply in 2016, to 3.0% of GDP, from 4.3% in 2015. This outturn was lower than we had expected at the time of the December review, and may be explained by a substantial degree of switching of tax payments to FY2016/17 ahead of changes to the treatment of dividend taxes. We expect the temporary boost to tax revenues to unwind this year, and spending to remain stable as a share of GDP, implying that the deficit will be broadly unchanged. Next year, lower spending as a share of GDP and higher revenues will result in a fall in the deficit to 2.4% of GDP. General government debt was 89.3% of GDP at end-2016 (more than twice the estimated 'AA' median of just under 40%). Our public finance projections imply that the government debt ratio will fall to 88.8% this year and 88.5% in 2018. If public debt develops in line with our projection, this calendar year will see the first fall in the government debt ratio since 2003. The UK economy remained resilient in 2H16, following the Brexit vote. Real GDP increased by 1.8% over 2016, with private consumption the main driver of growth. We assume that growth will slow down this year and next, as a result of the uncertainties related to the Brexit process weighing on firms' investment plans, and higher inflation eroding real incomes and pushing down on private consumption. We expect real GDP growth to be 1.5% this year, and to slow down further to 1.3% in 2018. Consumer price inflation has picked up since the referendum as sterling's depreciation has started to feed through to imported prices. CPI inflation (on the harmonised HICP measure) has increased to 2.3% in February and March this year from 0.3% in May 2016. We expect inflation to average 2.6% this year and 2.7% next year. Sterling's depreciation will provide support for external finances. The current account deficit will narrow as both the trade and income balances improve. We expect the current account deficit to fall back to 3.6% and 3.0% of GDP this year and next, from 4.4% in 2016. We estimate that net external debt fell to 14% in 2016, from 20.1% in 2015. Currency revaluations have led to a change in sign for the net international investment position, to +24% of GDP from -5% in 2015. We consider the UK major banks' capitalisation to be in line with their risk profile and that they would be able to withstand a moderate deterioration in market conditions at current ratings. The major UK banks had an aggregate common equity Tier 1 capital ratio of 15.1% in December 2016 although some banks are expected to pay large conduct fines and penalties, particularly in the US. The Prudential Regulation Authority recently asked financial institutions to present contingency planning for the UK's withdrawal from the EU. 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 consequences of the EU referendum are 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 relations with the EU that 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 growth prospects prove resilient to the consequences of the EU referendum. -Further improvements in the public finances leading to a steady decline 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 ratio declines from its current level (89.3% of GDP) to just over 78% by 2026. This scenario assumes, on average, real GDP growth of 1.8%, annual GDP deflator inflation of 1.9%, an average effective interest rate of 2.5%, and an average primary balance of 0.1% of GDP. Contact: Primary Analyst Alex Muscatelli Director +44 20 3530 1695 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Michele Napolitano Senior Director +44 20 3530 1882 Committee Chairperson Ed Parker Managing Director +44 20 3530 1176 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on Applicable Criteria Country Ceilings (pub. 16 Aug 2016) here Sovereign Rating Criteria (pub. 18 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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