Fitch Keeps UK Rating at ‘AA-‘ With Negative Outlook
Fitch Ratings has affirmed the United Kingdom’s (UK) Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘AA-‘ with a negative outlook. In its rating note, Fitch said the UK’s ratings reflect a high-income, large, diversified and flexible economy, a credible macroeconomic policy framework, deep capital markets and sterling’s international reserve currency status, which provides ample financing flexibility.
These strengths are set against high public and external debt, high debt service costs relative to peers and some remaining uncertainty regarding the final form of the UK-EU economic relationship post-Brexit, the rating note was added.
Also, Fitch explained that the Kingdom’s negative outlook reflects uncertain prospects for fiscal consolidation, given the challenging macroeconomic backdrop, including weak growth and the risk of more persistent inflation, expenditure pressures and the proximity of general elections.
The rating note indicates that recent faster-than-expected revenue growth has been directed towards tax cuts that could lift the UK’s growth potential in the medium term but fail to reduce public finances’ vulnerabilities due to high government debt and borrowing costs.
The review explained that the November Autumn Statement saw greater-than-projected revenues, leading to larger projected ‘headroom’ against the government’s main fiscal target.
“These were directed towards tax cuts and additional spending on welfare and health services that aim to lift growth prospects by supporting employment and investment, in the context of upcoming elections.
“The additional headroom came from the OBR’s higher projected inflation lifting nominal GDP forecasts, combined with the freeze of tax thresholds, which boosted revenue projections by more than the impact of higher inflation on interest payments and welfare.
“We forecast the general government fiscal deficit to reach 5.4% of GDP in 2023”, Fitch said.
Analysts said the full withdrawal of government’s temporary energy-related support measures and lower interest payments will lead the deficit to decline to 4.3% in 2024, which is above pre-pandemic levels and peers.
On the country’s risky fiscal strategy, the rating note explained that the November 2022 fiscal rules mandate a reduction in net public sector debt (excluding Bank of England; BoE) to GDP, and for public sector net borrowing not to exceed 3% of GDP, by the fifth year of the rolling forecast period.
The year for compliance with the rules is now the financial year ending April 2028. The headroom against the government meeting its first fiscal mandate, debt falling, is 0.4% of GDP and will likely remain small, as the government has signalled it could direct additional fiscal space towards tax cuts, according to the rating note.
Fitch said although the UK had a record of fiscal consolidation pre-pandemic, fiscal risks remain high, in analysts’ view, due to persistent inflation, the likelihood of continued high interest rates and the proximity of the elections.
Moreover, Fitch said it considers that projected real expenditure cuts underpinning the fiscal consolidation strategy will be difficult to implement.
The reformed fiscal rules provide significant flexibility to authorities to use projected fiscal space (against a rolling fiscal target) and come short of rebuilding the fiscal space utilised by successive shocks.
On the country’s higher debt, and strong financing flexibility, Fitch analysts forecast general government debt to rise from 100.8% of GDP in 2023 to 104.2% in 2025 and increase gradually thereafter.
This level would be more than double the forecast ‘AA’ median of 48% and limits the fiscal room for the UK to respond to future shocks, in Fitch’s view. The UK’s deep capital markets, absence of foreign-currency debt and sterling’s reserve currency status underpin the sovereign’s strong financing flexibility.
The long average maturity of government debt – 14.3 years in 2Q23 for gilts and T-Bills, nominal values – somewhat mitigates the immediate impact of higher financing costs, the rating note stated.
However, Fitch noted that interest payments are projected to increase to 10.8% of general government revenues in 2023, and will remain well above the projected ‘AA’ median of 2.8% in 2023-2024 due to payments on index-linked gilts (24% of government debt), higher debt, payments related to BoE Asset Purchase Facility reserves and increased borrowing.
With UK weak growth amidst easing inflation pressures, Fitch analysts project growth of 0.5% in 2023, and expect that a mild recession in 4Q23-2Q24 will pull down annual growth to 0.3% in 2024 before recovering to 1.8% in 2025.
“There is a high degree of uncertainty regarding the impact of government policies on long-term growth prospects. Annual inflation has eased, reflecting lower energy and food prices, but core inflation remains relatively high, signalling strong domestic demand pressures and a tight labour market.
“We forecast inflation to average 7.5% in 2023 and 3.1% in 2024, above the forecast 3.7% and 2.6%, respectively, for the median ‘AA’ rating peers”, Fitch said in the rating note.
Tightening the monetary policy, the BoE has lifted its main policy rate to 5.25% and analysts indicate an expectation that the monetary authority would maintain rates at this level at least until 3Q24.
This expectation is anchored on high growth in wages due to strong underlying inflationary pressures, partly due to tightness in the labour market, and the risk that inflation expectations become unanchored and stabilise above the 2% inflation target.
“We forecast the BoE will lower rates gradually, reaching 4.5% by end-2024 and 3% by end-2025”, Fitch said.
The rating note said as elections approach, the government has sought to restore economic policy predictability and rebuild confidence after an unusual period of political and policy volatility. Analysts said current polls show the opposition Labour Party with a strong lead over the ruling Conservative Party ahead of the general elections due by January 2025.
Fitch considers the next government will face a challenging mix of weak growth and limited fiscal room, and will likely have to balance electoral promises against expenditure pressures to avoid increasing fiscal vulnerabilities. #Fitch Keeps United Kingdom Rating at ‘AA-‘ with Negative Outlook Naira Devaluation Deepens Economic Crisis in Nigeria
