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- In our view, the U.K. has a wealthy, open, and diversified economy, supported by effective political institutions that can react quickly to economic challenges.
- We expect economic policy to continue to focus on closing the fiscal gap, and we forecast the U.K. government's net debt burden to peak in 2014.
- The U.K. benefits from what we see as a large liquid market for government debt issuance, entirely funded in domestic currency at long maturities.
- We are therefore affirming our 'AAA/A-1+' long- and short-term unsolicited sovereign credit ratings on the U.K.
- The stable outlook reflects our current expectation that the U.K. government will implement the bulk of its fiscal consolidation program and that economic growth will not falter more than what we currently project.
Standard & Poor's Ratings Services today affirmed its 'AAA' long-term and 'A-1+' short-term unsolicited sovereign credit ratings on the United Kingdom (U.K.) The outlook remains stable. The transfer & convertibility (T&C) assessment on the U.K. remains at 'AAA'.
The unsolicited ratings on the U.K. reflect our view of its wealthy and diversified economy, fiscal and monetary policy flexibility, and adaptable product and labor markets. We believe that the U.K. government maintains a strong commitment to implementing its fiscal mandate, and has the ability and willingness to respond rapidly to economic challenges. We also view the U.K. as having deep capital markets with strong demand for long-dated gilts by domestic and non-resident institutional investors alike.
In our view, the U.K. government's efforts over the next few years to engineer a steep correction in the fiscal accounts will likely drag on economic growth. At the same time, we expect that household spending in the short term will likely be dampened by sluggish nominal wage growth, a fragile labor and housing market, and a high, albeit falling, private sector debt burden--despite recent measures introduced to support private consumption. Nevertheless, we believe the U.K. economy's capacity to absorb shocks has improved. The household sector has developed a savings buffer and large corporations have accumulated substantial cash positions. There are other indications that a gradual rebalancing of the economy has started: net trade in goods and services made a positive contribution to GDP growth in 2011, partly in response to the 20% real-effective depreciation of the exchange rate since 2007. However, the pace of export volume growth slowed during 2011, largely due to a weakening external environment, which we expect to continue to negatively affect the U.K.'s export performance in 2012. Despite having run a current account deficit over the past two decades, the U.K.'s net international investment position has remained essentially stable as a percentage of output.
We expect the U.K. will post relatively modest real GDP growth of about 1.6% between 2012 and 2015, although we acknowledge that these projections are highly uncertain and subject to risks in either direction depending on domestic credit conditions and external developments. We expect the economy to reach 2007 output levels in real terms only in 2014. An accommodative monetary policy should, in our view, provide some support to the economy, as low interest rates keep private-sector debt-servicing costs moderate, and the currency at competitive levels. However, we also think that economic rebalancing may lead to lower growth in tax revenues than the Office for Budget Responsibility (OBR) currently projects, which could put pressure on public finances.
The government's fiscal aim is to balance the cyclically-adjusted current budget (which excludes the cyclical deficit and investment spending) by the end of a rolling five-year time horizon, currently fiscal-year 2016/2017. A supplementary target aims to see public sector net debt as a percentage of GDP falling by fiscal year 2015/2016.
We forecast a general government deficit of nearly 4.0% of GDP in calendar year 2015, using the accruals-based European (ESA 95) accounting standard, compared with the government's 2.9% projection for fiscal year 2015/2016. Standard & Poor's higher estimates for the deficit are largely based on our view that economic growth will likely be lower than that forecast by the OBR. Despite our projections for a slower pace of fiscal consolidation, we anticipate the general government net debt burden to peak in 2014 at just below 90% of GDP on an ESA 95 basis, before gradually declining. This compares to our previously published opinion (in October, 2011) that net general government debt would peak a year earlier, in 2013, and at a lower level. Nevertheless, we see general government debt of just under 90% of GDP as a sustainable burden for the U.K. in light of the country's advantages, namely its superior monetary and fiscal flexibility, economic resilience, and political resolve to stabilize public finances. Moreover, we see that the U.K. Treasury benefits from access to deep local currency capital markets, and the decisive backing of a lender of last resort, namely the Bank of England. The market-value weighted average maturity of U.K. government debt is more than 14 years, which should help contain the U.K. government's annual public gross borrowing needs compared with those of peer sovereigns.
We expect the U.K. political consensus on fiscal policy will broadly hold for the near future, and that the government will implement the measures specified in its fiscal consolidation program in order to achieve its targeted savings.
We assess the contingent liabilities stemming from systemic risk in the banking sector, public enterprises, and public finance initiatives as "moderate". Under our criteria, we consider that a "moderate" level of contingent fiscal liabilities could crystallize into government liabilities of between 30% and 60% of GDP in a deep and prolonged recession. That said, U.K. banks have recently improved their funding and liquidity profiles, evidenced by higher levels of customer deposits, flat-to-declining loan books, reduced absolute levels of wholesale funding, an improved funding maturity profile, and the maintenance of high liquid asset reserves. Although a large amount of term funding, of about £140 billion (9.3% of 2011 GDP), is set to mature in calendar year 2012, all the major banks have reported improvements in their term funding plans, aided by the general improvement in funding conditions for British banks so far this year and their use of the European Central Bank's long-term refinancing operation in February. Nevertheless, the banking sector is still dealing with the fallout from a high private sector debt burden and a property price correction, and its own deleveraging creates headwinds for the economy. The sector is also exposed to counterparty and rollover risk stemming from the interconnected European financial system.
The stable outlook reflects our current expectation that the government will continue to consolidate public finances, enabling net general government debt as a percentage of GDP to stabilize by 2014, and that the economic recovery will gain traction over the medium term.
We could lower the ratings if we came to the conclusion that the pace and extent of fiscal consolidation was slowing beyond what we currently expect. This could stem from a reappraisal of our view of the government's ability to implement its ambitious fiscal strategy. Downward pressure on the ratings could also come from materially weaker economic growth than we currently anticipate over the medium term. The household sector, which accounts for nearly two-thirds of GDP, remains vulnerable to an unexpected increase in interest rates as well as further falls in house prices. Finally, if--contrary to our current expectations--the U.K. banking sector were to require additional capital support, pressure on the sovereign ratings could build.
