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In its annual credit report on the United Kingdom, Moody's Investors Service says that the UK's Aaa debt rating is predicated on the country's significant structural strengths, but points out that the UK faces formidable and rising challenges. The significant increase in the UK government's deficit and debt metrics since 2008, the weaker macroeconomic prospects and the risks emanating from the euro area crisis mean that the UK's stable Aaa rating has a reduced ability to absorb further macroeconomic or fiscal shocks without rating implications.
The rating agency's report is an annual update to the markets and does not constitute a rating action.
In its report, Moody's gives the UK government high scores on the four factors underlying the rating agency's sovereign rating methodology: long-term economic fundamentals, institutional strength, government financial strength and susceptibility to event risk. Moody's describes the UK as having one of the most competitive of the large advanced economies in the world, and a track record of reversing increases in debt over many decades. The country's fiscal institutions are strong and have improved over the past 19 months with the establishment of the Office for Budget Responsibility. In addition, its national currency and central bank provide the UK with substantial flexibility in developing responses to economic and financial shocks. Debt refinancing risks are limited for the UK due to the long average maturity (nearly 14 years) of its debt, its large domestic investor base, and the willingness and ability of its central bank to purchase government debt.
Although Moody's expects these strengths to endure, the UK faces formidable and rising challenges. Its near-term macroeconomic outlook has weakened, and this will likely slow the pace of its fiscal consolidation. More generally, the significant increase in the government's deficit and debt stock since 2008 has eroded its ability to absorb further macroeconomic or fiscal shocks without rating implications.
The currently stable outlook on the UK government's Aaa rating depends in part on the assumption that the government will stay on track with its fiscal consolidation programme. However, any additional weakening in the macroeconomic outlook or a need to support the banking system could temporarily set back the government's fiscal consolidation efforts. As a result, the outlook on the rating is likely to be sensitive to future developments in the euro area's debt crisis, even though the UK is not a member of the monetary union.
In the absence of policy measures that significantly stabilise euro area credit markets in the near future, Moody's recently indicated that it will need to revisit the overall architecture of its sovereign ratings in the EU, which could lead to a repositioning of a large number of sovereign ratings. Although non-euro area sovereigns within the EU -- like the UK -- can be expected to be somewhat cushioned from both the euro area sovereign debt crisis and its rating consequences, Moody's says that no EU sovereign rating can be considered immune to this crisis.
