TEXT-Fitch revises UK's ratings outlook to negative

Wed Mar 14, 2012 4:16pm EDT

March 14 - Fitch Ratings has affirmed the United Kingdom's (UK) 	
sovereign ratings as follows: 	
	
--Long-term foreign currency Issuer Default Rating (IDR) affirmed at 'AAA'	
--Long-term local currency IDR affirmed at 'AAA'	
--Country Ceiling affirmed at 'AAA'	
--Short-term foreign currency rating affirmed at 'F1+' 	
	
The Outlooks on the Long-term IDRs have been revised to Negative from Stable. 	
	
The affirmation of the UK's 'AAA' ratings reflects the progress made in reducing	
the government's structural budget deficit and the credibility of the fiscal 	
consolidation effort. The UK's 'AAA' rating is underpinned by a high-income, 	
diversified and flexible economy as well as political and social stability. The 	
UK sovereign credit profile also benefits from the macroeconomic and financing 	
flexibility that derives from independent monetary policy and sterling's status 	
as an international 'reserve currency'. However, the government's structural 	
budget deficit is second in size only to the US ('AAA'/Negative) and 	
indebtedness is significantly above the 'AAA' median, although currently broadly	
in line with France ('AAA'/Negative) and Germany ('AAA'/Stable). 	
	
Fitch judges the government's fiscal consolidation plans to be credible, 	
reflecting the strong political commitment and institutional capacity. The 	
forthcoming Budget is expected to reaffirm the government's commitment to 	
deficit reduction as set out in the 2010 and 2011 budgets, the 2010 Spending 	
Review, and the 2011 Autumn Statement. The adjustment is focused on permanent 	
reductions in current spending underpinned by structural reform to public 	
services and welfare. The front-loaded fiscal consolidation is proceeding 	
broadly in line with the path set out by the government. The cyclically-adjusted	
primary deficit halved over the past two years, to 3.5% of GDP in 2011-12 from 	
7% of GDP in 2009-10, although the government's plans include further reductions	
in spending beyond the term of the current parliament. 	
	
The mix of tight fiscal and 'loose' monetary policies allowed for by the 	
flexible monetary and exchange rate regime, including 'quantitative easing' 	
(QE), is supportive of the necessary rebalancing of the UK economy. Although 	
Fitch recognises that the purpose of QE is to forestall deflationary pressures 	
and promote the flow of private credit, it has also reduced the government's 	
cost of fiscal funding and its reliance on the market, at least over the short 	
to medium term. Combined with an average maturity of government debt of over 14 	
years - around double that of its 'AAA' peers and a rating strength - on current	
policies the risk of a fiscal financing crisis is assessed to be negligible.    	
	
In Fitch's opinion, the credibility of the government's fiscal commitment was 	
further enhanced by the announcement in the Autumn Statement of additional 	
measures to ensure that the government's target of a cyclically-adjusted current	
budget surplus by 2016-17 and public sector net debt (excluding financial sector	
interventions, PSND ex) is falling in 2015-16 in response to the Office for 	
Budget Responsibility's (OBR) substantial re-assessment of the UK's economic 	
growth potential and growth prospects. Nonetheless, general government gross 	
debt (GGGD) and the government's preferred measure - PSND ex - are forecast by 	
the OBR to peak in 2014-15 at 93.9% and 78% of GDP, respectively, compared to 	
its previous forecast of 87.2% and 70.9% in 2013-14 at the time of the March 	
2011 Budget and Fitch's previous formal review of the UK's sovereign ratings. 	
Consistent with Fitch's sovereign rating criteria and historical and 	
international precedent, the projected peak for government indebtedness is at 	
the limit of the level consistent with the UK retaining its 'AAA' status. With 	
debt not expected to peak until 2014-15, three fiscal years from now, the risks 	
and uncertainty surrounding the realisation of debt reduction by the middle of 	
the decade are material. 	
	
The evolution of the eurozone debt crisis has significant implications for the 	
UK in light of the substantial trade and financial linkages between the two. The	
easing of financial market tensions in the eurozone in recent months has 	
diminished the risks to the UK, but in Fitch's opinion, the crisis is not 	
resolved and could once more intensify. Fitch's current assessment is that UK 	
banks are relatively well placed to absorb future episodes of financial market 	
turmoil and losses on eurozone exposures without additional recourse to the UK 	
taxpayer for capital. UK banks have strengthened their capital positions in 	
recent years and they have reduced their exposures to the weaker eurozone 	
economies over 2011.  In addition, the UK government has announced its 	
intentions to reform the banking system to make future crises less frequent and 	
costly. Both these factors should help reduce future fiscal risks. Of greater 	
concern would be the broader economic impact of an intensification of the 	
eurozone crisis on the UK government's ability to meet its deficit reduction 	
targets and place the debt to GDP ratio on a downward path in 2015-16.	
	
The revision of the rating Outlook to Negative from Stable reflects the very 	
limited fiscal space to absorb further adverse economic shocks in light of such 	
elevated debt levels and a potentially weaker than currently forecast economic 	
recovery. In light of the considerable uncertainty around the economic and 	
fiscal outlook, including the risks posed to economic recovery by ongoing 	
financial tensions in the eurozone and against the backdrop of a still large 	
structural budget deficit and high and rising government debt, the Negative 	
Outlook indicates a slightly greater than 50% chance of a downgrade over a 	
two-year horizon.	
	
The triggers that would likely prompt a rating downgrade are as follows: 	
-- Discretionary fiscal easing that resulted in government debt peaking later 	
and higher than currently forecast; 	
-- Adverse shocks that implied higher levels of government borrowing and debt 	
than currently projected; and	
-- A material downward revision of the assessment of the UK's medium-term growth	
potential. 	
	
Conversely, economic and fiscal performance in line with Fitch's baseline 	
expectations with general government gross debt peaking at around 94% in 2014-15	
would likely result in the stabilisation of the rating Outlook. In the absence 	
of adverse shocks, Fitch does not expect to resolve the Negative Outlook until 	
2014. The agency's medium-term economic and fiscal projections are set out in a 	
new Special Report on UK Public Finances, available at www.fitchratings.com.	
	
Fitch last formally reviewed the UK sovereign ratings on 14 March 2011 and has 	
completed the current review in a manner consistent with its regulatory 	
obligations.
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