LONDON – July 27, 2012 – Standard & Poor’s Ratings Services today said it affirmed its ‘AAA’ long-term and ‘A-1+’ short-term unsolicited sovereign credit ratings on the United Kingdom. The outlook remains stable. The transfer and convertibility (T&C) assessment on the U.K. remains at ‘AAA’.
Our view of the U.K.’s wealthy and diverse economy, fiscal and monetary policy flexibility, and adaptable product and labor markets support our unsolicited ratings on the sovereign. In our opinion, the U.K. government remains committed to implementing its fiscal program, and we believe it can respond rapidly to economic challenges. We also view the U.K. as having deep capital markets with strong demand for long-dated government bonds (gilts) by both domestic and nonresident institutional investors. The market-value weighted average maturity of U.K. government debt is more than 14 years, which helps contain the government’s annual public gross borrowing needs compared with those of peers.
We also expect that the Bank of England (BoE)’s monetary policy, which we view as highly accommodative, will help keep the government’s borrowing costs in check. The BoE’s monetary policy includes its Asset Purchases Facility, under which a total of £375 billion in gilts will have been purchased between March 2009 and November 2012.
In early 2012, the U.K. economy fell back into recession the economy contracted in three consecutive quarters starting in fourth-quarter 2011 following tepid growth in the preceding two years. As a result, output in real terms remains roughly 4.5% below its pre-crisis peak.
We currently expect real GDP growth to begin to recover in the second half of 2012 and to strengthen steadily thereafter. We base our projections on the government’s current fiscal consolidation plans, an assessment of recently introduced measures designed to support and shield the economy, and the assumption that the eurozone will stabilize. We acknowledge the downside risks associated with these projections. For example, the fiscal framework allows automatic stabilizers to operate, which means that a reversal in the recent decline in unemployment would likely slow the pace of fiscal consolidation. Similarly, sluggish nominal wage growth and a high albeit falling private-sector debt burden will restrain household spending, which contributes about two-thirds to GDP. Finally, because private domestic demand is subdued, corporate investment is unlikely to recover strongly until the external environment stabilizes the euro area accounts for nearly half of the U.K.’s overall trade.
Nevertheless, we believe that the U.K. economy’s capacity to absorb shocks has improved. Household savings have increased and large corporations have accumulated substantial cash holdings. In addition, the authorities have introduced a series of measures to support the economy, including the Funding for Lending Scheme, further quantitative easing, and the Extended Collateral Term Repo (ECTR) facility. In our opinion, these should help to keep private-sector borrowing costs low, ensure a steady supply of credit in the event of further stress in the international capital markets, and maintain a competitive exchange rate. The latter would help to increase the share of exports in GDP, a shift that the global slowdown has recently interrupted.
The government’s fiscal aim is to balance the cyclically adjusted current budget (which excludes the cyclical deficit and investment spending) by the end of a rolling five years currently fiscal 2016/2017. A supplementary target is to have public-sector net debt falling as a percentage of GDP in fiscal year 2015/2016. By 2011/2012, the government has achieved almost 40% of the annual fiscal consolidation laid out in the Spending Review 2010 (mainly on the revenue side), and it is going to continue its focus on expenditure measures for the remainder of the fiscal cycle. We currently expect that the coalition government’s consensus on fiscal policy will hold and that the government will implement the measures specified in its fiscal consolidation program to achieve the targeted savings.
We forecast a general government deficit of nearly 4.0% of GDP in calendar-year 2015, down from an estimated 6.8% in 2012, using the accruals-based European (ESA 95) accounting standard, compared with the government’s 2.9% projection for fiscal 2015/2016. Our higher estimates largely reflect our view that economic growth will likely be lower than what the Office for Budgetary Responsibility (OBR) has forecasted. We expect the general government net debt burden to remain at nearly 92% of GDP in 2014 and 2015, owing to our assumption of slightly slower fiscal consolidation, before gradually declining.
Notwithstanding domestic banks’ declining net interest margins and potential prolonged litigation and customer redress risk, we have not changed our assessment of the British banking system, which we rank in BICRA group ‘3’ (see “Banking Industry Country Risk Assessment: U.K.,” published Jan. 27, 2012). U.K. banks continue to be focused on building capital buffers, generally by shedding risk-weighted assets and muted new lending, rather than by raising capital. This deleveraging will continue to create headwinds for the economy, although the Funding for Lending Scheme could counter these issues. We note that banks have improved their funding and liquidity profiles, as demonstrated by higher levels of customer deposits, flat-to-declining loan books, reduced absolute levels of wholesale funding with a longer maturity profile, and higher coverage of short-term wholesale funding by primary liquid assets. Nevertheless, the sheer size of the domestic financial system and its external exposure weigh on our appraisal of the U.K.’s fiscal debt position.
The stable outlook reflects our expectation that the government will continue to consolidate public finances, enabling net general government debt as a percentage of GDP to stabilize by 2014 (and remain at a similar level in 2015 before declining), and that an economic recovery will begin to gain traction. It also reflects our view that governance issues with specific institutions, changes in EU-wide bank or tax policy, or greater financial stress in the eurozone will not affect London’s position as a preeminent financial center.
We could lower the ratings in particular if the pace and extent of fiscal consolidation slows beyond what we currently expect. This could stem from a reappraisal of our view of the government’s ability to implement its fiscal strategy or from significantly weaker economic growth than we currently anticipate.