(Alliance News) - Moody's Investors Service on Friday downgraded the UK government's long-term issuer and senior unsecured ratings to Aa3 from Aa2, with its outlook changed to stable from negative.
Moody's also downgraded the Bank of England's long-term issuer and senior unsecured bond ratings to Aa3 from Aa2 and (P)Aa3 from (P)Aa2 for the senior unsecured MTN programme. Moody's affirmed the P-1 short-term issuer rating. The outlook on these ratings was also changed to stable from negative.
According to the ratings agency "the three key drivers for this action are closely related and mutually reinforcing."
The first of these it that the UK's economic strength has diminished since Moody's downgraded the rating in September 2017 to Aa2. Growth since then "has been meaningfully weaker than expected and is likely to remain so in the future", Moody's said, with the UK's negative long-term structural dynamics exacerbated by its decision to exit the EU and its inability to reach a trade deal since then that can meaningfully replicate the benefits of EU membership.
Moody's added that "Growth will also be damaged by the scarring that is likely to be the legacy of the coronavirus pandemic, which has severely impacted the UK economy."
The second factor, Moody's said, is the erosion of the UK's fiscal strength.
Moody's explained that: "General government debt, already high and sticky prior to the crisis, has risen further as a result of the pandemic. While the UK's reserve currency status provides a high capacity to carry debt, the material increase in debt poses risks to debt affordability in future years, particularly in the absence of a clear plan to reduce government indebtedness.
"Notwithstanding recent statements of intent by the government, it is in Moody's view unlikely that the government will be able meaningfully to rebuild the UK's fiscal strength in the coming years given the low growth environment and the likely political obstacles to doing so."
The third and final driver of the downgrade related to the UK's weakened institutions and governance in recent years, underlying the other two drivers.
"While still high, the quality of the UK's legislative and executive institutions has diminished in recent years. Policymaking, particularly with respect to fiscal policy, has become less predictable and effective. Looking forward, the self-reinforcing combination of low potential growth and high debt in a fractious policy environment will create additional headwinds to addressing the economic, fiscal and social challenges that the UK faces," Moody's said.
The ratings agency said the stable outlook reflects the country's "intrinsic economic and intuitional strengths", with Moody's expecting that the UK's debt will stabilise at the current level.
The UK's foreign and local currency bond ceilings, as well as its local-currency deposit ceiling, have not changed and remain at Aaa, while the foreign-currency long-term deposit ceiling has been lowered to Aa3 from Aa2. The UK's short-term foreign-currency bond and bank deposit country ceilings remain at P-1.
The ratings outlook and ultimately the rating could improve if it was indicated that the apparent erosion in institutional strength was reversing, Moody's said. It highlighted that "indications that British institutions are reverting to the capability and predictability that has traditionally characterised the UK's institutional framework would be positive."
Meanwhile, if it became clear that the UK's fiscal strength was likely to further deteriorate as a result of growth pressures, higher-than-expected deficits, or higher funding costs, then the ratings could face further downward pressure.
"A further structural weakening in economic fundamentals would also undermine the UK's credit profile. While it is unlikely at this stage, indications that sterling's status as a reserve currency was in question would also exert downward pressure on the outlook and eventually the rating," said Moody's.
By Anna Farley; annafarley@alliancenews.com
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