Rating action

Scope Ratings GmbH (Scope) has today affirmed the United Kingdom’s long-term local- and foreign-currency issuer and senior unsecured debt-category ratings at AA, maintaining Stable Outlooks. The short-term issuer ratings have been affirmed at S-1+ in local- and foreign-currency, and Stable Outlooks are maintained.

The affirmation of United Kingdom’s AA long-term ratings reflects several credit strengths, such as: i) the reserve-currency status of sterling, gilts as a global safe asset and deep capital markets; ii) strong institutions such as sound financial supervisory, economic and monetary governance frameworks alongside an independent monetary policy; iii) a robust sovereign debt structure with long average maturities and strong market access; alongside iv) a large, wealthy and diversified national economy, which has proven resilient since the Covid-19 pandemic and cost-of-living crises.

Challenges for the long-term credit ratings of the United Kingdom include: i) elevated and rising public debt, and an elevated budget deficit; ii) a weak external sector given recurrent current-account deficits; and iii) extended uncertainty surrounding the implementation of post-Brexit UK-EU trading arrangements.

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Key rating drivers

Reserve-currency status, gilts as a global safe asset and deep capital markets. The UK benefits significantly from access to deep domestic capital markets, the City of London as one of the world’s leading financial centres, gilts’ status as a global safe asset and sterling’s standing as a primary global reserve currency. The share of global allocated reserves held in GBP has risen over the more-recent decades despite significant institutional challenges like Brexit alongside the rise of alternative reserve currencies – from 2.8% as of 2000 to 4.9% in Q2 2024.

Strong institutional framework alongside an independent monetary policy. The UK rating is bolstered by its robust financial-, economic- and monetary-governance frameworks – alongside an independent monetary policy as managed by the Bank of England – among the oldest central banks globally. This strong institutional architecture allows for a swift response to and the capacity to withstand economic and financial-market crises, such as recently during September 2022 in an episode of market turmoil involving pension funds and unfunded expansionary budgetary measures.

Robust structure of the sovereign debt. The UK’s credit ratings are supported by strong market access, alongside an exceptionally-long average government debt maturity of 14.2 years¹, significantly longer than averages of peer sovereign borrowers such as Belgium (10.7 years), France (8.4) and the United States (5.9). The Bank of England is the largest single holder of gilts and treasury bills (holding around 28% of the aggregate as of Q1 this year¹), although quantitative tightening is expected to gradually reduce this share over the coming years. As sovereign ratings are assigned on debt held by the private sector, this share owned by the Bank of England effectively trims the aggregate (rated) debt ratio.

Like the experiences of peer sovereign states, the UK’s funding costs rose since 2021 due to higher inflation and tighter monetary policy even though UK sovereign yields are currently slightly off their peaks as inflation has declined and the Bank of England has begun gradually to cut rates. However, >30% of outstanding government debt will need to be re-financed by 2029, and maintaining investor confidence in the sovereign’s fiscal sustainability remains crucial to support the significant debt-issuance plans of the (Keir) Starmer government.

A large, wealthy and well-diversified economy. The UK’s ratings are anchored by a large, wealthy and diversified economy, which has proven resilient since Covid-19 pandemic and cost-of-living crises. Following the global pandemic, output reached again pre-pandemic levels already by late 2021. Although the economic outlook has recently remained fragile, comparatively-high wealth and a diversified economic base are significant factors underscoring resilience of the economy. Output growth was just 0.3% last year and Scope estimates real growth to stay subdued around 0.9% this year before 1.4% in 2025 as high funding rates affect private consumption and investment.

Rating challenges: Rising government debt, a weak external sector and post-Brexit uncertainties.

Moderate economic growth, elevated government debt and elevated interest rates limit space for easing budgetary policies in preparation for the Starmer government’s Autumn Budget later this month. The effects for the public-debt trajectory from slightly-higher-than-anticipated growth this year are offset by elevated primary budget deficits. The government debt ratio is seen exceeding 111% of GDP by 2029, from 100% as of 2022 and 86% in 2019 pre-pandemic – projected to surpass pandemic-crisis highs by 2026. Chancellor of the Exchequer Rachel Reeves is considering adjustments to the debt target to allow more space for investment expenditure, although several tax locks pre-announced before the elections have restricted budgetary flexibility.

The British economy displays a comparatively-weak external position, given recurrent current-account deficits over the recent decades. Before the pandemic crisis, this deficit averaged 3.4% of GDP over 2017-19, wider than the averages of economies of sovereign peers. It moderated to 0.4% of GDP during the pandemic crisis in 2021 before re-rising to a moderate 2.2% by the year to Q2 2024. The IMF estimates the current-account deficit to average 2.8% of GDP over years 2024-29.

Despite more-constructive engagement with the European Union as seen in the Windsor Framework agreement, long-run challenges and uncertainty remain regarding the post-Brexit UK-EU trading relationship. The UK Office for Budget Responsibility has concluded that Brexit has had an adverse effect for British trade by curtailing trade volumes with EU firms. This is expected to see trading intensity cut 15% compared against the scenario of the UK having remained within the European Union² as new trade arrangements with non-EU economies are unlikely to fully compensate for the decline in trade with EU counterparts.

Political divisions in Northern Ireland also remain an issue post-Brexit. However, after a two-year boycott, the Democratic Unionist Party reached agreement early this year with the British government and a Northern-Irish government was restored. Scope anticipates negotiations between the UK and EU to prove more constructive moving ahead, including on the subject of Northern Ireland, even if this may be unlikely to materially change the long-run economic costs of Brexit.

Outlook and rating sensitivities

The Stable Outlook represents the view that risks for the ratings over the forthcoming 12 to 18 months are comparatively balanced.

The downside scenarios for the long-term ratings and Outlooks are if (individually or collectively):

1. There are observable challenges for UK gilts’ long-held status as a global safe haven and/or attenuation of sterling’s status as a reserve currency;
    
2. Protracted fiscal deterioration results in weakened debt sustainability beyond present expectations; and/or
    
3. The medium-run growth outlook weakened significantly.

Conversely, upside scenarios for the long-term ratings and Outlooks are if (individually or collectively):

1. The agency observed an unexpected significant upgrading of the fiscal outlook such as perceived stabilisation of the public-debt ratio through the cycle; and/or
    
2. External vulnerabilities were curtailed significantly.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals an initial indicative credit rating of ‘a+’ on the United Kingdom. Under Scope’s sovereign-rating methodology, this initial indicative rating receives: i) a further one-notch positive adjustment from a methodological reserve-currency adjustment to account for sterling; alongside ii) no negative adjustment from the methodological political-risk quantitative adjustment. On this basis, a final SQM quantitative rating of ‘aa-’ is assigned for the United Kingdom and next reviewed by an analyst-driven Qualitative Scorecard (QS) – where the model’s final indicative rating can be adjusted by up to three notches up or down depending on the significance of the United Kingdom’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states assigned by the SQM (model).

The primary analyst identified in this QS the following analytical categories as relative credit strengths of the United Kingdom: i) monetary policy framework; ii) macro-economic stability and sustainability; iii) debt profile and market access; iv) banking sector performance; and v) financial sector oversight and governance. Conversely, the following relative credit weaknesses are identified in the QS: i) fiscal policy framework; and ii) external debt structure. On the aggregate, the QS generates a one-notch positive adjustment for the United Kingdom’s long-term ratings, concluding in AA long-term credit ratings.

A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues in its ratings process via the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

The UK receives an above-average SQM score on the model’s environmental-risk sub-pillar, reflecting lower carbon-emissions intensity per unit of output and lesser risks from climate-change-associated natural disasters, the latter as captured by indices managed by the Notre Dame Global Adaptation Initiative, compared against the exposures of economic peers. Nevertheless, the country receives weaker marks regarding the ecological footprint of consumption compared against available biocapacity. Alongside the SQM evaluation of environmental risks, Scope assesses the UK’s performance on environment vis-à-vis a second-stage QS analytical category evaluating environmental factors. This QS assessment remains set at ‘neutral’ against the UK’s sovereign peers – resulting in no adjustment for the ratings. In their manifesto ahead of the 2024 general elections, Labour committed to introduction of an ‘Energy Independence Act’ for creation of a framework allowing the nation to become ‘a clean-energy superpower’ and establish a publicly-owned clean power company. The seventh carbon budget will need to be agreed next year and a new Nationally Determined Contribution for 2035 needs to be defined between November 2024 and February 2025³.

Regarding social considerations (‘S’), the United Kingdom receives slightly below-median scores under the SQM social-risk sub-pillar, with strong scoring from: i) high labour-force participation; and ii) below-median levels of income inequality – as measured by the share of income held by the poorest 90% of the population – offsetting a weak score on old-age dependency – although the latter score remains comparatively favourable against that of advanced-economy rating peers. Scope expects the fragile economic outlook and elevated mortgage rates to aggravate balance-sheet pressures of vulnerable households, in turn raising a risk of social exclusion and increasing the need for future government support. Between December 2021 and 2023, increases in interest rates are estimated to have pushed up mortgagor poverty rates by 1.4pps⁴. On the complementary QS assessment of qualitative ‘social factors’, this assessment against sovereign peers of the United Kingdom remains ‘neutral’.

Under governance-related factors as captured by the SQM governance sub-pillar, the UK achieves a stronger-than-average score on five World Bank Worldwide Governance Indicators (WGIs). In addition, on the separate methodological political-risk adjustment, political risk is assessed as being low, resulting in no negative adjustment for the indicative model rating. The UK benefits from high-quality institutions under parliamentary democracy, which has helped steer the nation through domestic political tribulations following the vote to exit the European Union in 2016. At the same time, scoring on five of the six WGI categories has weakened since the EU referendum and scoring for categories of government effectiveness, voice and accountability, the rule of law, regulatory quality and control of corruption is either at or near all-time lows since WGI rankings started in 1996. Election results from July of this year are largely perceived as having strengthened political stability. After an agreement with the UK government in January of this year, political tensions have eased in Northern Ireland. On the complementary analyst assessment under the ‘governance factors’ QS (qualitative) analytical category, this assessment against sovereign peers remains ‘neutral’.

Rating committee
The main points discussed by the rating committee were: i) the results of the general elections; ii) economic sentiment; iii) Autumn Budget 2024; iv) debt definitional changes and market response; v) fiscal rules and debt sustainability; vi) political climate; vii) Brexit; and viii) sovereign peers developments.

Rating driver references
1. UK Debt Management Office. Quarterly Review (April - June 2024).
2. Office for Budget Responsibility. Economic and fiscal outlook (March 2024).
3. UK Parliament (House of Commons Library). The UK’s plans and progress to reach net zero by 2050 (26 September 2024).
4. UK Institute for Fiscal Studies. Living standards, poverty and inequality in the UK: 2024 (25 July 2024).

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 4.0), 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 and 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/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings and/or Outlooks were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Dennis Shen, Senior Director
Person responsible for approval of the Credit Ratings: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 3 November 2023.

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, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.