June 13, 2014 / 4:05 AM / in 4 years

Fitch Affirms UK at 'AA+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, June 13 (Fitch) Fitch Ratings has affirmed the United Kingdom's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA+'. The Outlooks are Stable. The issue ratings on the UK's senior unsecured foreign and local currency bonds have also been affirmed at 'AA+'. The Country Ceiling has been affirmed at 'AAA' and the Short-term foreign currency IDR at 'F1+'. KEY RATING DRIVERS Favourable macroeconomic trends, including strong GDP growth, falling unemployment and inflation close to the 2% target, have continued in the UK economy since our last review in December 2013. Quarterly GDP growth has been strong, on average 0.8% qoq, since 2Q13, the least volatile among the major advanced economies. Fitch judges growth to be partly cyclical, reflecting the gradual closing of the previous large output gap. The 2014 budget adopted in March reiterated the government's multi-year fiscal consolidation path. The Office for Budget Responsibility forecasts a 5% deficit/GDP ratio, using the EU Treaty definition, for the 2014-15 fiscal year, compared with 6% in 2013-14 and 11.4% in 2009-10. While the strengthening economic recovery supports the fiscal consolidation efforts, the fiscal deficit remains large compared with rating peers and the 'AA' median of a 1.5% surplus. The current rules of the fiscal mandate provide less guidance on future fiscal policy, although most of the remaining consolidation will fall to the next parliament. The fixed date of the debt target (2015-16) gives no guidance on the desired debt trajectory beyond the peak. As consolidation progresses, the requirement to reach the balanced position in five years is becoming less challenging, reducing the constraint on discretionary fiscal measures. Fitch expects gross general government debt (GGGD), using the EU Treaty definition, to peak at 92%-93% of GDP in 2015-16 and to start falling in 2017, when the primary balance turns positive. Debt remains among the highest of 'AA' and 'AAA' rated sovereigns. The UK's ratings are underpinned by its high-income, diversified and flexible economy as well as a high degree of political and social stability. Strong civil and policy institutions and a high degree of transparency enhance the predictability of the business and economic policy environment, which compares favourably with peers in the 'AA' category. The credible monetary policy framework and sterling's international reserve currency status afford the UK a high degree of financial and economic policy flexibility. The UK's current account deficit widened to 4.4% of GDP in 2013 from 1.5% in 2011, compared with a surplus for the 'AA' median. This was mainly due to a sharp deterioration in net investment income, which turned negative for the first time in more than a decade. The long average maturity of public debt (15 years, the longest of any high-grade sovereign) exclusively denominated in local currency and low interest service burden implies a higher level of debt tolerance than many high-grade peers. The substantial improvement in the UK banking sector's capital and liquidity position has further reduced contingent liabilities arising from the sector and as recent developments illustrate, the financial sector is increasingly able to support the economic recovery by better transmitting the loose monetary conditions to borrowers. At the same time, recent rapid increase in the house price-to-income ratio, in particular in London, could lead to excessive leverage if supported by unsustainable lending practices. If unchecked over the longer term, this would increase macroeconomic risks and could also have a knock-on impact on the sovereign's fiscal position. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main factors that could lead to a negative rating action, individually or collectively, are: - Failure to place the GGGD to GDP ratio on a firm downward path over the medium term or greater uncertainty over the implementation of budget consolidation efforts. - Adverse macroeconomic or financial shocks that significantly slow the economic recovery, adversely affecting the public finances or the financial sector. - In the event of a 'yes' vote in the Scottish referendum, Fitch would review the rating, focusing on potentially adverse effects on public debt, external finances, the currency arrangement and the financial sector (see 'UK: Rating Implications of Scottish Independence,' 10 April, for further details). The main factors that could lead to a positive rating action, individually or collectively, are: - Sustained lower budget deficits, leading to a track record of significant decline in the GGGD to GDP ratio from its peak. - Clear indication of higher medium-term growth potential than currently forecast. KEY ASSUMPTIONS Fitch expects the UK economy to grow by 3% in 2014 as the recovery is becoming more broad based and forecasts a mild slowdown to 2.5% in 2015. Fitch maintains its view that medium-term growth potential is in the range of 2%-2.25%, while recognising that the size of the output gap is particularly uncertain, when spare capacity is declining fast in the labour market, but improvement in productivity has so far been well below the pace of previous recoveries. Notwithstanding the recent pattern, over the forecast horizon Fitch expects employment growth to slow and to be more aligned with historical examples of improving productivity during the recovery. The strong institutional framework for control of public expenditure and effective tax administration alongside the broad-based political and public commitment to deficit reduction underpins Fitch's assumption that fiscal consolidation will be sustained beyond the term of the current parliament. Fitch also assumes that stability-oriented fiscal policy will be maintained amidst any new fiscal rule. Fitch forecasts inflation to remain close to the 2% inflation target in 2014 and 2015 and over the medium term. This assumes that Bank of England will be able to tighten monetary conditions gradually without excessive market volatility as the recovery progresses and existing slack is reduced. Nevertheless the task of normalising monetary conditions after keeping the interest rates unchanged close to the zero lower bound for more than five years, while holding GBP 375bn government bonds (22% of GDP) on its balance sheet is historically unprecedented. Fitch assumes that no contingent liabilities arising from the financial sector or privatisation receipts will have a material impact on the path of UK government debt over the rating horizon. The net effect of the methodological changes in the ESA 2010 rules on the EU Treaty GGGD, including the reclassification of Network Rail from private sector to central government and other changes, will not exceed 2% of GDP. According to provisional ONS data, revisions will increase the level of current price GDP by 4.6% or GBP65bn in 2009 (latest available year), half of which is due to ESA2010 methodology. Fitch will base its forecast on revised data after all EU countries switch to the new ESA 2010 methodology by September. In the event of a 'yes' in the Scottish referendum there would be a transition period, where many details, large and small, would need to be agreed. Fitch assumes that the transition would be managed carefully, avoiding financial dislocations. If not, the downside pressure on the ratings would be greater. In line with its global economic outlook report, Fitch expects the recovery in major advanced economies, including the eurozone, the UK's largest trading partner, to strengthen gradually in 2014-15, while emerging markets growth will be broadly stable, avoiding the risk of sharp slowdown. Contact: Primary Analyst Gergely Kiss Director +44 20 3530 1425 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Douglas Renwick Senior Director +44 20 3530 1045 Committee Chairperson Ed Parker Managing Director +44 20 3530 1176 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria, 'Sovereign Rating Criteria' dated 13 August 2012 and 'Country Ceilings' dated 09 August 2013, are available at www.fitchratings.com. Applicable Criteria and Related Research: Sovereign Rating Criteria here Country Ceilings here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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