Rating Action: Moody's changes the outlook on the UK to negative, affirms Aa3

ratings
21 Oct 2022
London, October 21, 2022 -- Moody's Investors Service ("Moody's") has today changed the outlook on the
Government of the United Kingdom's (UK) ratings to negative from stable and affirmed the domestic and
foreign-currency long-term issuer and domestic-currency senior unsecured ratings at Aa3.
The outlook on the Bank of England's (BoE) ratings has also changed to negative from stable and its Aa3
long-term foreign- and domestic-currency issuer and foreign-currency senior unsecured bond ratings, as well
as its (P)Aa3 foreign-currency senior unsecured MTN programme rating have been affirmed. The short-term
domestic- and foreign-currency issuer ratings have also been affirmed at Prime-1. Moody's rates the BoE at
the same level as the Government of the UK given it is an essential part of the government's economic policy
framework and is fully owned by the government.
Saltaire Finance plc's Aa3 backed senior secured and (P)Aa3 backed senior secured MTN programme ratings
have also been affirmed, based on credit substitution. The affirmation reflects the unconditional and irrevocable
guarantee of scheduled principal and interest on the bonds secured under the programme provided by the
UK's Secretary of State for Housing, Communities and Local Government at the Ministry of Housing,
Communities and Local Government. The bonds are issued by Saltaire Finance plc in connection with the
management and delivery of the Affordable Homes Guarantee Scheme.
The change in outlook to negative from stable is driven by:
1. Heightened unpredictability in policymaking amid weaker growth prospects and high inflation; and
2. Risks to the UK's debt affordability from likely higher borrowing and risk of a sustained weakening in policy
credibility.
The evolution of policymaking, and the UK government's ability to engender confidence in its commitment to
fiscal prudence, will be a material consideration for Moody's in resolving the negative outlook. An outlook
period typically lasts 12-18 months.
The affirmation of the Aa3 rating reflects the UK's economic resilience supported by its wealthy, competitive
and diversified economy. Despite the weakening in fiscal policy predictability in recent years, the country's
long-standing institutional framework remains strong and will continue to support the UK's ability to respond to
shocks, as seen during the pandemic. Furthermore, the structure of the UK government debt, with a very long
average maturity of around 15 years, as well as a deep domestic investor base adds a degree of resilience to
the credit profile in the face of shocks.
The UK's local and foreign currency country ceilings remain unchanged at Aaa. The three-notch gap between
the local currency ceiling and the sovereign rating is driven by the government's relatively small footprint in the
economy, a fairly robust external payments position and a diversified economy. The foreign currency ceiling at
the same level as the local currency ceiling reflects a fully convertible capital account as well as reasonably
effective policy management.
Please click on this link https://www.moodys.com/viewresearchdoc.aspx?docid=PBC_ARFTL469291 for the
List of Affected Credit Ratings. This list is an integral part of this Press Release and identifies each affected
issuer.
RATINGS RATIONALE
RATIONALE FOR THE CHANGE IN OUTLOOK TO NEGATIVE FROM STABLE
FIRST DRIVER: HEIGHTENED UNPREDICTABILITY IN POLICYMAKING AMID WEAKER GROWTH
PROSPECTS AND HIGH INFLATION
The first driver of the change in outlook to negative is the increased risk to the UK's credit profile from the
heightened unpredictability in policymaking amid a volatile domestic political landscape, which challenges the
UK's ability to manage the shock arising from weaker growth prospects and high inflation. Moody's considers
policy predictability a Governance consideration under its ESG framework.
Moody's views the 23 September fiscal statement, together with the subsequent reversal of most of the
measures announced and the forthcoming change in prime minister, as a continuing reflection of the
weakening predictability of fiscal policymaking seen in previous years. That policy statement outlined
significant fiscal outlays without detailed policy plans and independent scrutiny from the Office for Budget
Responsibility (OBR). The government's initial inability to deliver a credible policy response to address investor
concerns around this unfunded stimulus further weakened the UK's policy credibility, which is unlikely to be
fully restored by the subsequent decision to reverse most of the tax cuts and plans to shortly publish a
medium-term fiscal strategy alongside an OBR forecast. Overall, the episode illustrates the increasing
polarisation and unpredictability of the domestic political environment, which may undermine efforts to deliver
on fiscal consolidation amid likely demands to further alleviate cost of living pressures.
At the same time, the economic outlook has worsened as high inflation, weaker external demand, and the
rising cost of borrowing – exacerbated by volatile financial market conditions in the aftermath of the
government's September fiscal announcement – weigh on consumption, investment and economic activity.
The recently announced energy price cap means inflation will peak lower than initially forecast, providing some
support, although Moody's expects real disposable incomes will materially decline over the coming year
particularly as the energy price cap likely becomes more targeted from April 2023. Real GDP growth has been
slowing since the beginning of 2022 and will continue to soften in the coming quarters, with Moody's
forecasting growth will average just 0.3% over 2023-2024 and not return to its potential level of 1.5% until
2026.
Moreover, Moody's expects the Bank of England will significantly further tighten monetary policy in light of the
risk of more persistent inflation over the medium term and to ensure long-term inflation expectations remain
anchored amid the heightened volatility in financial markets. The tighter monetary policy in turn will weigh on
economic growth.
Furthermore, medium-term economic growth will face headwinds from Brexit and lower labour participation
following the pandemic as well as longstanding constraints to productivity growth. Even under the Trade and
Cooperation Agreement reached with the European Union (EU, Aaa stable) at the end of 2020, Brexit will
continue to weigh on trade, investment and the labour market, reducing long-term productivity by around 4%.
Weaker medium-term growth will further exacerbate the already-evident tensions around fiscal policy settings.
SECOND DRIVER: RISKS TO THE UK'S DEBT AFFORDABILITY FROM LIKELY HIGHER BORROWING
AND RISK OF A SUSTAINED WEAKENING IN POLICY CREDIBILITY
The second driver of the decision to change the outlook to negative is the heightened risks to the UK's debt
affordability from likely higher borrowing and the risk of more persistent inflation. A sustained erosion of the
UK's policy credibility could also lead to higher borrowing costs in the medium term.
The combination of a weaker growth outlook and a likely wider budget deficit than Moody's previously
forecasted will keep general government debt consistently above 100% of GDP in the coming years and
elevate risks to the debt trajectory. Notwithstanding the reversal of most aspects of the September fiscal
announcement, Moody's expects the budget balance to deteriorate given likely demands to further alleviate
cost of living pressures, which will challenge efforts to deliver on fiscal consolidation in the absence of any
credible fiscal anchor. The government faces very acute spending pressures as high inflation increases the
interest paid on inflation-linked debt and erodes the real-term increases in departmental budgets that were set
in nominal terms in October 2021. Furthermore, significant cuts to public spending are likely to prove politically
difficult ahead of the next general election due before January 2025.
The prospect of higher borrowing, more persistent inflation, and a more significant tightening in monetary
policy leading to higher funding costs has increased risks to the UK's debt affordability over the medium term.
Weakening debt affordability would be of heightened significance for the UK's fiscal strength given sterling's
status as a reserve currency.
The current high levels of inflation – Moody's expects inflation to peak close to 11% within the next six months
– will add to interest costs in the near term given that close to a quarter of the UK's government debt has its
cost linked to inflation. Moody's forecasts interest payments on government debt will rise by around £40
billion in 2022 before moderating as the very high levels of inflation gradually recede over the coming years.
That said, Moody's expects interest payments would still absorb around 7.5% of UK government revenue in
2025, a larger share than before the pandemic, with inflation forecast to remain above the 2% target until 2026.
Moreover, while Moody's ratings tend to look through short-term market volatility, the recent rise in government
bond yields is in part a reflection of wider market concerns around the credibility of UK policymaking, adding to
the risk that the UK's cost of funding remains higher in the medium term. Despite recent gilt purchases, the
planned gradual unwinding by the central bank of its large government debt holdings will also likely keep
pressure on funding costs and shift debt towards more risk-sensitive private-sector holders over the medium
term.
RATIONALE FOR AFFIRMING THE Aa3 RATINGS
The affirmation of the Aa3 ratings reflects the UK's economic resilience supported by its wealthy, competitive
and diversified economy even though the challenges posed by Brexit and the pandemic have weakened
medium-term growth.
While fiscal policy predictability has been weakening for a number of years, Moody's expects the country's
strong long-standing institutional framework, including its rule of law, central bank, professional civil service
and the OBR, will continue to support the UK's ability to respond to shocks, as seen during the pandemic.
Despite the elevated risks, Moody's expects the government debt-to-GDP ratio will still remain broadly in line
with advanced economy peers such as France (Aa2 stable, 109% of GDP) and Belgium (Aa3 stable, 105% of
GDP) in 2023.
Furthermore, the very long average maturity of UK government debt, which, at around 15 years, compares
favourably to the median of Aa-rated peers of around 9 years, will keep gross borrowing requirements low
relative to other highly rated and indebted sovereigns, supporting a higher capacity to carry a large debt
burden and slowing the pass-through from rising funding costs to debt affordability.
In addition, the UK's deep domestic investor base has, in Moody's view, sufficient capacity to absorb new
government debt, which will help to mitigate the credit impact of a loss in foreign investor confidence.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
The UK's ESG Credit Impact Score is neutral to low (CIS-2), reflecting low exposure to environmental and
social risks and, like many other advanced economies, a strong governance profile and in general capacity to
respond to shocks.
Its overall E issuer profile score is neutral to low (E-2), reflecting low exposure to environmental risks across
most categories.
We assess its S issuer profile score as neutral to low (S-2), reflecting low exposure to social risks over most
categories. The only category that entails moderately negative risk is demographics: demographic change in
the form of relatively fast ageing of the population poses long-term fiscal sustainability challenges to the UK,
while Brexit will likely lead to lower immigration over the medium term. Health care in particular will become an
increasingly important source of fiscal risk in the absence of reforms. The UK's labour and income score
reflects the country's very flexible labour market as well as rising income and wealth inequalities, which have
had political and policy ramifications.
The UK's G issuer profile score (G-1) is supported by its strong institutions and governance profile. Although
policy predictability has been weakening for a number of years, the UK's institutions continue to score highly
on international surveys, reflecting high-quality legislative and executive institutions, and a strong civil society.
Coupled with high wealth levels and moderate government financial strength, this supports a high degree of
resilience.
GDP per capita (PPP basis, US$): 50,523 (2021) (also known as Per Capita Income)
Real GDP growth (% change): 7.5% (2021) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 5.4% (2021)
Gen. Gov. Financial Balance/GDP: -8% (2021) (also known as Fiscal Balance)
Current Account Balance/GDP: -2.6% (2021) (also known as External Balance)
External debt/GDP: 303.5% (2021)
Economic resiliency: a1
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 18 October 2022, a rating committee was called to discuss the rating of the Government of the United
Kingdom. The main points raised during the discussion were: The issuer's economic fundamentals, including
its economic strength, have not materially changed. The issuer's institutions and governance strength, have
decreased. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The
issuer's susceptibility to event risks has not materially changed.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
WHAT COULD MOVE THE RATINGS UP
The negative outlook indicates that an upgrade is unlikely. Moody's could return the outlook to stable if the
heightened risks to the UK's economic and fiscal prospects were to moderate. In particular, evidence that the
UK authorities are able to deliver on a credible medium-term fiscal strategy, that reduces the risks of a
deterioration in the UK's fiscal strength and helps avoids a more sustained weakening in the government's
policy credibility, could lead to a stabilization of the outlook. Continued confidence in the UK's long-standing
institutions to help navigate the current heightened uncertainty without detriment to the UK's economic and
fiscal strength would be a prerequisite for a stabilization in the outlook.
WHAT COULD MOVE THE RATINGS DOWN
A sustained deterioration in the UK's debt affordability, including from higher government borrowing and
persistently high inflation and/or persistent concerns around the credibility of UK policymaking, which leads to
a sustained rise in the UK's cost of funding and materially weakens Moody's assessment of fiscal strength,
would exert downward pressure on the rating. A sharp and sustained rise in government debt relative to peers
would also be negative for the rating.
While unlikely, concerns around the UK's funding of its current account deficit, indicating concerns that could
ultimately lead to lower demand for sterling as a reserve currency and therefore persistently higher borrowing
costs, would exert downward pressure on the rating. Finally, a significant weakening in the UK's economic
fundamentals including its medium-term growth prospects would also undermine the UK's credit profile.
The principal methodology used in these ratings was Sovereign Ratings Methodology published in November
2019 and available at https://ratings.moodys.com/api/rmc-documents/63168 . Alternatively, please see the
Rating Methodologies page on https://ratings.moodys.com for a cpy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
REGULATORY DISCLOSURES
The List of Affected Credit Ratings announced here are a mix of solicited and unsolicited credit ratings. For
additional information, please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings
available on its website https://ratings.moodys.com. Additionally, the List of Affected Credit Ratings includes
additional disclosures that vary with regard to some of the ratings. Please click on this link
https://www.moodys.com/viewresearchdoc.aspx?docid=PBC_ARFTL469291 for the List of Affected Credit
Ratings. This list is an integral part of this Press Release and provides, for each of the credit ratings covered,
Moody's disclosures on the following items:
• EU Endorsement Status
• UK Endorsement Status
• Rating Solicitation
• Issuer Participation
• Participation: Access to Management
• Participation: Access to Internal Documents
• Lead Analyst
• Releasing Office
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections
Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and
Definitions can be found on https://ratings.moodys.com/rating-definitions.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain
regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series,
category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from
existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this
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assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms
have not changed prior to the assignment of the definitive rating in a manner that would have affected the
rating. For further information please see the issuer/deal page for the respective issuer on
https://ratings.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this
credit rating action, and whose ratings may change as a result of this credit rating action, the associated
regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following
disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated
entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment
resulting from that disclosure.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related
rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit
analysis can be found at https://ratings.moodys.com/documents/PBC_1288235 .
At least one ESG consideration was material to the credit rating action(s) announced and described above.
Please see https://ratings.moodys.com for any updates on changes to the lead rating analyst and to the
Moody's legal entity that has issued the rating.
Please see the issuer/deal page on https://ratings.moodys.com for additional regulatory disclosures for each
credit rating.
Evan Wohlmann
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London, E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Alejandro Olivo
MD-Sovereign/Sub Sovereign
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London, E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

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