Rating agency Fitch affirmed UK at ‘AA’ and removed them from Rating Watch Negative (RWN). The Outlook is Negative. Forecast highly likely UK leaves EU with an agreement on Jan 31 2020. Uncertainty regarding future of UK and EU relations for some time.
Rating agency Fitch affirmed UK at ‘AA’ and removed them from Rating Watch Negative (RWN). The Outlook is Negative. Forecast highly likely UK leaves EU with an agreement on Jan 31 2020. Uncertainty regarding future of UK and EU relations for some time.
Highlights
- UK election outcome has significantly reduced the very near term risk of a no deal Brexit
- Large degree of uncertainty on fiscal outlook fiscal loosening likely, extent uncertain
- Assuming it is ratified by the EU, the UK will leave the EU at the end of next month.
- A transition period, whereby almost all EU law would continue to apply in the UK, would last at least until end-2020.
- In our view, there is a risk that a self-imposed hard deadline could see the UK accept unfavourable terms.
Fitch Note on UK Post December 12 Election
Key Rating Drivers
HIGH
The outcome of the UK general election on 12 December means it is highly likely that the UK will leave the EU with a Withdrawal Agreement on 31 January 2020. This removes the short-term risk of a disruptive ‘no-deal’ Brexit, where the UK would leave the EU without a Withdrawal Agreement in place and is reflected in the removal of the RWN and affirmation of the UK’s ‘AA’ rating.
The Conservative Party secured a parliamentary majority of 80 seats in last week’s general election. The government will set out its agenda in a Queen’s Speech on 19 December, and plans to table legislation to approve the Withdrawal Agreement negotiated with the EU in October before year-end.
Given the sizeable majority, we expect the Withdrawal Agreement will be passed and the Withdrawal Agreement bill enacted. Assuming it is ratified by the EU, the UK will leave the EU at the end of next month. A transition period, whereby almost all EU law would continue to apply in the UK, would last at least until end-2020. The election outcome has thus significantly reduced the very near-term risk of a no-deal Brexit.
The Negative Outlook reflects our view that uncertainty regarding the future UK-EU relationship will persist for some time, including the terms of the future UK-EU relationship in trade and other areas such as security cooperation. The size of the new Conservative government’s majority will reduce UK political volatility, but also presents the party leadership with trade-offs as it balances the concerns of its new supporters in England’s northern and midland regions with its hard-line Eurosceptic wing in its negotiations with the EU.
The UK’s IDRs also reflect the following key rating drivers:
The government’s attitude towards extending the transition period beyond end-2020 will be a relevant factor in our rating assessment. Prime Minister Boris Johnson has pledged not to extend the transition period, but EU officials have often said publically that completing a Free Trade Agreement in less than a year may prove unrealistic. In our view, there is a risk that a self-imposed hard deadline could see the UK accept unfavourable terms. Although such deadlines have been missed in the past, the risk of a disruptive ‘cliff-edge’ departure by the UK at end-December 2020 from its trading relationship with the EU has not disappeared.
A majority government could support the UK’s political stability and government effectiveness, but this may also depend on how the Conservative leadership manages competing interests in its upcoming term. Three years of Brexit negotiations have strained UK politics and weakened policy cohesion, paralysing the policy making process, and negatively impacting UK governance indicators. The composite World Bank Governance Indicator for the UK dropped to an historical low in 2018 due to a marked deterioration in the ‘Political Stability’ per cent rank to 48.1 from 59.0. In Fitch’s sovereign rating criteria, governance indicators carry the heaviest weight in our Sovereign Rating Model.
The impact of Brexit uncertainty on the economy has been palpable. Business investment declined again in 3Q19 – it has fallen for six out of the last seven quarters – while revised data show that the household savings ratio has been rising steadily since the end of 2016. A decisive reduction in Brexit uncertainty could provide a short-term boost to growth, but a more lasting benefit from plans to increase public investment will depend on how effectively this is targeted. We expect real GDP growth of 1.3% in 2019 and 2020.
There is a large degree of uncertainty around the fiscal outlook. Fiscal loosening is likely but the extent of it remains uncertain. The Conservatives pledged during the campaign to balance the current budget (i.e. excluding capex) within three years and reduce debt-to-GDP over the next parliament. These new fiscal rules would allow for substantial fiscal loosening, increasing risks to our debt projections. The budget announcement planned for Spring 2020 will be the first important indicator of how much of the new fiscal headroom will be utilised.
The UK’s ratings balance a high-income, diversified and advanced economy against comparatively high public sector indebtedness. Sterling’s reserve currency status, deep capital market and strong (albeit deteriorating) governance indicators further support the ratings.
The very long average maturity of public debt (15 years) is among the highest among Fitch-rated sovereigns and mitigates refinancing and interest rate risks. Public debt (86% of GDP) is almost exclusively in sterling, so a weaker exchange rate has not led to a deterioration in debt dynamics. 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 Foreign Currency 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
Developments that could result, individually or collectively, in a downgrade include:
-Developments that lead to a post Brexit UK-EU relationship that undermines the UK’s economic performance and the public finances, potentially including a disruptive ‘cliff-edge’ departure by the UK from its trading relationship with the EU
-Fiscal loosening or weaker GDP growth leading to an increase in the government debt/GDP ratio over time, and widening further the gap to the historical ‘AA’ median ratio
Developments that could result in the Outlook being revised to Stable include:
-Improvements in the public finances leading to a sustained decline in the government debt to GDP ratio
-Greater confidence and evidence that the UK’s growth prospects and public finances will prove resilient to the consequences of Brexit.
Key Assumptions
Fitch assumes that the Withdrawal Agreement is passed and the Withdrawal Agreement Bill enacted over the coming weeks and that as a result the UK will leave the EU in an orderly manner on 31 January 2020. ESG Considerations
The UK has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and is therefore highly relevant to the rating and a key rating driver with a high weight.
The UK has an ESG Relevance Score of 5 for Rule of Law, Institutional and Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in the SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.
The UK has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as World Bank Governance Indicators have the highest weight in the Sovereign Rating Model and are relevant to the rating and are a rating driver.
The UK has an ESG Relevance Score of 4 for Creditor rights as willingness to service and repay debt is relevant to the rating and is a rating driver, as for all sovereigns.
Source: Fitch Ratings
From The TradersCommunity Research Desk