For the updated report accompanying this review, click here.

Rating action

Scope Ratings GmbH (Scope) has today affirmed the United Kingdom’s AA long-term issuer and senior unsecured debt ratings in local- and foreign-currency, along with its short-term issuer rating of S-1+ in both local and foreign currency. All Outlooks remain Stable.

Summary and Outlook

Scope’s affirmation of the United Kingdom’s AA ratings reflects the UK’s: i) strong institutions including robust financial supervisory, economic and monetary governance frameworks; ii) large, wealthy and diversified economy, which has proved resilient since the Covid-19 pandemic and the energy crisis; and iii) robust government debt profile with long average maturities and strong market access.

Rating challenges include: i) the country’s high level of public debt and a challenging fiscal and economic outlook; ii) a weak external position with persistent current account deficits; and iii) the prolonged uncertainties surrounding the implementation of the post-Brexit UK-EU trade agreement.

The Stable Outlook reflects Scope’s view that risks to the ratings are balanced over the next 12 to 18 months.

The ratings/Outlooks could be downgraded if, individually or collectively: i) a protracted fiscal deterioration resulted in a significantly weaker fiscal outlook and a steepening of the rising debt trajectory; ii) the medium-term growth outlook weakened significantly, for example caused by a financial or economic shock; iii) external vulnerabilities increased or sterling’s status as a reserve currency weakened; and/or iv) the country’s governance profile weakened.

Conversely, the ratings/Outlooks could be upgraded if, individually or collectively, the UK’s: i) public finances improved, resulting in a material improvement in the fiscal outlook including a downward trajectory of public debt in the medium term; and/or ii) external vulnerabilities were reduced.

Rating rationale

The United Kingdom’s AA ratings are supported by the country’s robust institutions and a renewed focus on fiscal discipline following the sharp market reaction to the unfunded expansionary fiscal measures announced in the mini-budget last year. A weakening of the country’s institutions and/or governance profile in future could be credit negative for the rating.

The large fiscal loosening put forward by the previous government in September 2022 has been replaced by fiscal consolidation supported by a medium-term fiscal framework including independent oversight through the Office for Budget Responsibility (OBR). In a reflection of the UK’s strong institutions, the Bank of England’s temporary and targeted financial stability operation following the mini-budget proved highly effective at stabilising the gilt market, allowing Liability-Driven Investment (LDI) funds time to recapitalise and adjust their leverage positions and liquidity mismatches between assets and liabilities, thereby containing fire-sale dynamics¹. Effective implementation required close coordination with His Majesty’s Treasury, the Prudential Regulation Authority, the Pensions Regulator and the Financial Conduct Authority, as well as regulators in Ireland and Luxembourg, where LDI funds tend to be domiciled.

The fiscal tightening announced by the current government led by PM Rishi Sunak is backloaded with a significant part of the spending cuts taking effect only from 2025, after the next general election. Scope expects the government to adhere to its fiscal targets in the run-up to the next general election and restrain from large fiscal giveaways, which could lead to upward pressure on inflation.

The United Kingdom’s fiscal framework has been amended frequently as there are no constitutional anchors that require significant cross-party support to approve changes. As a result, since the introduction of the Charter for Budget Responsibility in 2011, the framework was adjusted on six occasions, most recently in January 2023² with the introduction of two new, less restrictive fiscal rules to be met under the OBR's projections: i) net debt as a share of GDP falling by the fifth year of the rolling five-year forecast horizon rather than the previously targeted third year; and ii) public sector net borrowing targeted at less than 3% of GDP over the same period. While the targets instil a degree of fiscal discipline, they also offer a high degree of flexibility to adjust plans in future years as rolling targets, in principle, never require net debt or public sector net borrowing to actually decrease.

To retain the country’s fiscal credibility, it is important that any future government remains committed to fiscal targets. With the next general election likely to be held in late 2024, Scope notes positively the opposition’s announced intention to maintain a similar fiscal framework³, including targeting a current budget surplus and a falling debt-to-GDP ratio over a five-year period. Additional proposals could also strengthen the framework somewhat by making it a legal requirement to publish forecasts by the OBR and introducing clear mechanisms for suspending the fiscal targets in response to an economic shock.

The UK’s debt-to-GDP ratio peaked at 105% of GDP during the pandemic in 2020, well above AAA-rated economies such as Germany (69%) and the Netherlands (55%), but below aa-rated peers such as France (115%) and Belgium (112%). Scope expects the debt ratio for the UK to increase from around 103% in 2023 to 110% by the end of the forecast horizon in 2028 as the relaxation of the fiscal framework in January 2023 increases flexibility. To date, only three Chancellors have been in office for more than five years, and past governments tended to loosen fiscal policy when forecast revisions provided an increased headroom but have not sufficiently tightened fiscal policy when forecasts showed a worsening outlook⁴.

The combination of slow growth, elevated debt, and higher interest rates limits the room to ease fiscal policy in the run-up to the next general election if the government intends to stick to its fiscal targets. This is despite borrowing in the first six months of 2023-24 being below the OBR’s March forecasts⁵, largely due to higher tax receipts. The OBR’s November forecasts are expected to factor in higher interest rates and changes in long-term assumptions for interest rates, which can materially limit the potential additional headroom the government faces. While the UK faces significant structural spending pressures, the country still has a relatively modest tax burden of 33.5% of GDP compared to its peers such as France (45.1%) or Belgium (42%)⁶. This provides some room to raise taxes to help meet spending commitments but also to achieve a gradual fiscal consolidation. Scope expects the general government budget deficit to decline from 4.7% in 2022 to around 3.5% over the forecast horizon until 2028. Significant deviations from this expected gradual fiscal consolidation and the resulting stabilisation of the UK’s debt-to-GDP trajectory would be credit negative.

The AA ratings are also underpinned by the UK’s large, wealthy and diversified economy, which has proved broadly resilient to the Covid-19 pandemic and the energy crisis. The data revisions outlined by the Office for National Statistics in September 2023 significantly change the UK’s post-Covid economic narrative⁷. As of Q2 2023, GDP is now 1.8% above 2019 levels and already recovered from the pandemic shock by Q4 2021, compared to previous estimates which saw GDP still being below pre-pandemic levels. However, the recovery since end-2019 remains weaker than in peer countries such as the United States (+6.1% above 2019 levels) or Belgium (+4.6%) but is now aligned with that of France (+1.8%).

While the near-term economic outlook remains weak, comparatively high wealth levels, a very diversified economic base and a flexible labour market continue to be significant resilience factors. Scope expects GDP growth of 0.6% in 2023, remaining weak at 0.5% in 2024 as higher interest rates impact private consumption and investments slow. Economic growth is then forecast to be near the medium-term growth potential of 1.5%, which is broadly in line with that of peer countries such as the United States (2%), France (1.4%) and Belgium (1.2%).

Scope’s growth forecasts account for the fact that, similar to many developed economies, the UK will see its finances strained by inflationary pressures and interest rates, as well as increasing households’ vulnerability to future shocks. Higher interest rates impact household finances with a short lag as most mortgages in the UK have interest rate fixation periods of either 2 or 5 years. Financing pressures have caused house prices to fall by 5.3% in the twelve months to September 2023 according to Nationwide and further declines in 2024 are likely. So far around half of mortgage accounts have refinanced at higher rates, with the remaining (around 4 million) facing refinancing by end-2026. The Bank of England expects the aggregate mortgage debt-servicing ratio to reach around 8% of post-tax income, remaining below historical peaks of around 10% in the 2007-08 global financial crisis⁸. Partially due to tighter macroprudential policies in recent years, the household debt-to-income ratio has decreased over the past 15 years, reaching 129% in Q1 2023, its lowest level since 2003. This increased borrower resilience has helped to contain payment difficulties. While arrears on residential loans to individuals have been increasing since Q3 2022 and are expected to increase further, this is from historically low levels. In the corporate sector, the number of insolvencies has increased over the past year, as particularly some smaller firms that rely on bank funding at variable interest rates face payment difficulties.

The Bank of England’s annual cyclical scenario stress test⁹ indicates that the UK banking system would be resilient to its UK households and corporates exposures in the event of a severe macroeconomic shock, with aggregate common equity tier 1 capital levels remaining above the aggregate hurdle rate of 6.9%. The scenario assumes a 5% decline in GDP, sharp falls in asset prices, high interest rates globally and a large rise in unemployment to 8.5%.

Supporting the growth outlook is also the UK’s tight labour market, although the slowing economy resulted in the employment rate easing slightly from recent highs to 75.5% in July while the unemployment rate increased to 4.3% from lows of 3.5% in 2022. Scope expects the unemployment rate to average 4.3% this year and increase to around 4.6% in 2024. Labour shortages still constitute a challenge in some sectors, although there has been a decline in the total number of unfilled vacancies over the past year, signalling a continued easing in labour demand. The tightness in the labour market has supported robust nominal wage growth (+7.6% YoY in August), exceeding CPI inflation since June, causing a gradual stabilisation in real incomes. Wage growth and labour market developments will remain an important factor for the Bank of England in future policy rate decisions.

Finally, the UK’s AA ratings reflect strong market access, with an exceptionally long average government debt maturity of 14.3 years as of June 2023, well above peer sovereigns such as Belgium (10.4 years), France (8.5 years) and the United States (6.2 years). The Bank of England is the largest holder of gilts and treasury bills (around a third of the total), though quantitative tightening is expected to reduce this share over the coming years.

Similar to peers, funding costs have been increasing steadily since H2 2021 in a context of higher inflation and tighter monetary policy. Approximately 30% of the government’s total outstanding debt will have to be re-financed over the next five years. As illustrated by the September 2022 market turmoil, investor confidence in the UK’s fiscal sustainability will remain important to support debt issuance as part of the fiscal consolidation plans.

The UK continues to benefit from deep capital markets and the City of London’s position as one of the world’s leading financial centres, backed by a sophisticated financial regulatory framework. The Bank of England’s independent monetary policy and sterling’s status as a global reserve currency contribute to the country’s ability to withstand economic shocks. The share of global allocated reserves held in sterling declined slightly during the mini-budget market turmoil, but recovered quickly to historic highs, standing at 4.9% in Q2 2023.

Despite these credit strengths, the UK faces several credit challenges.

Firstly, the country faces a high level of public debt and a challenging fiscal and economic outlook. The gradually increasing debt-to-GDP ratio is only marginally lower at 104% in 2023 than that of other highly indebted peers such as Belgium (rated AA-/Negative) and France (AA/Negative).

The expected gradual rise in the debt-to-GDP ratio in combination with a high share of inflation-linked bonds, rising interest rates and past quantitative easing by the Bank of England result in an elevated interest burden. As regularly highlighted by the OBR, even though the UK’s public debt benefits from a high average maturity, quantitative easing operations by the Bank of England in recent years have significantly increased the sensitivity of net debt interest spending to changes in short-term interest rates¹⁰. Net interest payments as a share of revenue rose from 2.9% in 2020 to 8.6% in 2022. The ratio is likely to remain above most similarly-rated countries in 2024 at around 5.1% – compared with Belgium (3.5%), France (3.5%) and the Czech Republic (2.5%).

Government revenue and spending pressures are likely to persist in the near term. In its March 2023 forecast, the OBR estimates that the tax burden will reach 37.7% of GDP by 2027-28, reaching its highest level since the Second World War. This includes the highest level of corporation tax receipts to GDP since the introduction of the tax in 1965. The higher revenues will help fund spending priorities such as continued high interest expenses and rising spending pressures in the health service. The IMF estimates a net present value of health care spending over 2022-50 in the UK of 64.6% of GDP¹¹, well above that of other large European economies such as Spain (51.9%), France (49.4%), Germany (38.8%) and Italy (27.2%). Over the forecast horizon, public spending to GDP is therefore expected to remain above 43%, its highest sustained level since the 1970s.

Secondly, several structural weaknesses remain as productivity growth remains low compared with pre-financial crisis trends. This is despite the positive GDP revisions that place the UK’s post-pandemic recovery in line with weaker countries in the peer group such as France. Business investment has lagged since the Brexit vote in 2016 with non-dwellings investments up only 12.3%, closer to that of weaker G7 nations such as Germany and Japan, and well below France (+24%), the United States (+26%) and Italy (+28%). Some structural pressures in the labour market also persist. While the cumulative change in economic inactivity since the pandemic has improved over the past year, the number of people reporting being out of the labour force due to long-term sickness is still high at over 400,000.

Thirdly, the UK has a relatively weak external position, with persistent current account deficits for several decades. Before the pandemic, the deficit averaged 3.5% of GDP over 2017-19, significantly larger than the peer country average. It fell to 1.5% during the pandemic in 2021 on the back of robust services exports, before increasing again to 3.8% as the trade deficit widened due to a negative terms-of-trade shock caused by sharply higher energy prices following the escalation of the war in Ukraine. Scope expects the external balance to remain near pre-pandemic levels, in line with IMF forecasts, which estimate the current account deficit to average 3.6% of GDP over 2023-28. There remains considerable uncertainty around these expectations given the evolving impact of the EU-UK Trade and Cooperation Agreement and any final agreement between the EU and the UK on financial services.

Finally, despite a more constructive engagement with the EU as reflected by the Windsor Framework agreement, long-term challenges and uncertainties surrounding the implementation of the post-Brexit UK-EU trade agreement remain. The OBR notes that Brexit had a clear adverse impact on UK trade by reducing trade volumes as well as lowering the number of trade relationships with EU firms. This is expected to result in the trade intensity being 15% lower in the long run than if the UK had remained in the EU¹² as new trade deals with non-EU countries are not expected to materially offset the expected decline in trade with European partners.

The aftermath of the Brexit vote continues to cause political divisions in Northern Ireland. There has been no functioning government in Northern Ireland following the election in May 2022 as the Democratic Unionist Party has so far refused to restore power-sharing if the Northern Ireland protocol is not resolved. Scope expects negotiations between the UK and EU to be more constructive going forward, even if this is unlikely to change the long-term economic costs associated with Brexit.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides a first indicative rating of ‘a’ for the United Kingdom. This receives a further one-notch positive adjustment under the methodology’s reserve-currency adjustment to account for sterling. As such, under Scope’s methodology, a final ‘a+’ indicative rating can be adjusted by the Qualitative Scorecard (QS) by the lead analyst by up to three notches depending on the size of relative qualitative credit strengths or weaknesses compared to a peer group of countries.

For the United Kingdom, the following relative credit strengths via the QS have been identified: i) monetary policy framework; ii) macro-economic stability and sustainability; iii) debt profile and market access; iv) resilience to short-term external shocks; v) banking sector performance; and vi) banking sector oversight. Conversely, the following relative credit weaknesses have been identified: i) external debt structure.

The combined relative credit strengths and weaknesses identified in the QS result in a net two-notch positive adjustment for the United Kingdom. This indicates a final sovereign credit rating of AA for the United Kingdom.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG sustainability issues during its ratings process via the sovereign methodology’s standalone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS).

The UK receives an above average CVS score with regards to environmental factors, reflecting lower levels of greenhouse gas (GHG) emissions per unit of GDP as well as per capita relative to most rating peers. Furthermore, the country receives weaker marks regarding the ecological footprint of its consumption compared with available biocapacity, and for its resilience to natural disaster risks. Scope assesses the UK’s QS adjustment for environmental factors as ‘neutral’. The government announced several policy changes in September that weaken the UK’s previous carbon reduction commitments¹³. This included pushing back the planned ban on the sale of new petrol and diesel cars from 2030 to 2035 and introducing exemptions for some households regarding the installation of new gas boilers. In addition, stricter energy efficiency rules for landlords were abandoned and a ban on the installation of new oil boilers has been postponed from 2026 to 2035. The Prime Minister stressed that despite these changes, the UK will still meet its target to reach carbon neutrality by 2050. In particular, the government intends to improve the country’s energy infrastructure, encourage private investments in offshore and onshore wind energy, invest in further carbon storage facilities and build new nuclear reactors.

Regarding social factors, the UK receives average scores in the CVS, with high labour force participation and average levels of income inequality balancing a low score on old-age dependency – though the latter remains favourable relative to that of rating peers. Scope expects the weak economic outlook, with low real wage growth and rising mortgage rates, to aggravate the current cost of living crisis for vulnerable households, in turn raising risks of social exclusion and increasing the need for future government support.

Under governance-related factors captured in the CVS, the UK achieves an average score on six World Bank Worldwide Governance Indicators (WGIs) that is higher than most sovereign peers. The UK benefits from the high quality of its institutions under its parliamentary democracy, which has helped to steer the country through volatile domestic political changes since the vote to leave the EU in 2016. At the same time, five of the six WGI scores have weakened since the EU referendum in 2016; scores for government effectiveness, voice and accountability, rule of law, regulatory quality and control of corruption are either at or near all-time lows since the rankings began in 1996. Political gains by the nationalist Sinn Féin party in the Northern Ireland elections in 2022 and by the pro-independence Scottish National Party (SNP) in 2021 fuelled debates on independence referendums over the medium term, although the resignation of SNP’s Nicola Sturgeon has significantly slowed the pro-independence momentum in Scotland.

Rating Committee
The main points discussed by the rating committee were: i) domestic economic risk; ii) public finance risks, including fiscal framework and debt dynamics; iii) external risks; iv) financial stability risks, including housing market and private sector debt; v) ESG considerations; and vi) peer developments.

Rating driver references
1. IMF: Putting Out the NBFire: Lessons from the UK’s Liability-Driven Investment (LDI) Crisis, September 2023 
2. House of Commons Library: The UK’s fiscal targets, September 2023 
3. Financial Times, Rachel Reeves: From the OBR to new fiscal rules, we will bring back stability, September 2023 
4. IFS Green Budget 2023, Chapter 5, October 2023 
5. Office for Budget Responsibility, Public Sector Finances: September, October 2023 
6. OECD, Revenue Statistics 2022 – the United Kingdom 
7.  Office for National Statistics, Impact of Blue book 2023 changes on gross domestic product, September 2023 
8.  Bank of England, Financial Stability Report, July 2023 
9.  Bank of England, Stress testing the UK banking system: 2022/23 results, July 2023 
10. Office for Budget Responsibility, Debt maturity, quantitative easing and interest rate sensitivity, March 2021 
11. IMF, Fiscal Monitor October 2023
12. Office for Budget Responsibility, Economic and fiscal outlook, March 2023 
13. Prime Minister’s Office, PM speech on Net Zero: 20 September 2023 

Methodology
The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 27 September 2023), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks (Core Variable Scorecard Model Version 2.1), is available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party participation   YES
With access to internal documents                                 NO
With access to management                                          YES
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Eiko Sievert, Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Executive Director
The ratings/outlook were first assigned by Scope in January 2003. The Credit Ratings/Outlooks were last updated on 25 November 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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