By Mark McSherry
Moody’s Investors Service has changed its outlook on the government of the United Kingdom’s ratings to negative from stable.
Moody’s maintained its sovereign rating for the United Kingdom at “Aa3”.
Moody’s said its change in outlook to negative from stable is driven by “heightened unpredictability in policymaking amid weaker growth prospects and high inflation” and “risks to the UK’s debt affordability from likely higher borrowing and risk of a sustained weakening in policy credibility.”
The Office for National Statistics (ONS) said this week that debt interest payable of the UK government was £7.7 billion in September 2022 — £2.5 billion more than in September 2021 and the highest September figure since monthly records began in April 1997, according to latest figures from the Office for National Statistics (ONS).
The ONS said UK public sector net debt excluding public sector banks (PSND ex) was £2.45 trillion at the end of September 2022 — around 98% of gross domestic product (GDP) and an increase of £213 billion or 2.5 percentage points of gross domestic product (GDP) compared with September 2021.
Moody’s said: “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 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 …
“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.”