UK debt a ‘key weakness’, says Moody’s

High household debt means economy vulnerable to house price shock

UK debt a ‘key weakness’, says Moody’s

The United Kingdom’s (Aa1 stable) economic growth will likely remain solid in 2015-16, but its high debt burden remains a key weakness, said Moody’s Investors Service in a report published yesterday.

According to Moody’s, the UK’s economic growth will likely remain robust, with real GDP forecast to increase by 2.7% and 2.4% in 2015 and 2016, respectively. “However, the UK’s economic growth pattern remains relatively unbalanced and mainly driven by domestic demand and the services sector, while exports and manufacturing remain subdued”, said Kathrin Muehlbronner, a senior credit officer and author of the report.

Muehlbronner also noted the continuing high level of household debt, which makes households and the banking sector vulnerable to a house price shock or rapid increases in interest rates.

Longer-term growth challenges for the UK economy might arise if the weak productivity performance of the past several years persists. In Moody’s view, it is positive that the government aims to address the weakness of productivity growth through measures such as large-scale infrastructure investment and reforms to improve the skill levels in the workforce, although none of these reforms will likely bring quick results. Longer-term economic growth prospects have an important bearing on Moody’s assessment of the UK’s economic strength.

Moody’s also views the government’s track record and continuing strong commitment to reduce the elevated budget deficit as credit positive. The government intends to bring the public finances back into balance by the end of the fiscal year 2018-19 and focus the adjustment predominantly on the spending side.

Moody’s believes that the government will indeed manage to reduce the budget deficit substantially over the coming years, given its commitment as well as robust GDP growth and a continuing low interest-rate and inflation environment. At the same time, the rating agency believes that achieving the spending cuts targeted by the government might be difficult to achieve in full, and the agency therefore expects a more moderate reduction in the budget deficit, to just above 1% of GDP by the end of this parliament.

This pace of fiscal consolidation would be sufficient to engineer a gradual reduction in the public debt ratio from 2017 onwards. Moody’s notes that the UK’s government debt ratio — forecast to peak at a level of 91.5% o f GDP in 2016 —is high by global standards, although less so by European standards. The government’s planned sales of some of its bank and corporate shareholdings would be positive, but would be too small in size to materially change the public debt dynamics, says Moody’s.

Risks to sovereign rating

Moody’s has identified two idiosyncratic risks which could affect the UK’s sovereign rating. Firstly, the referendum on the UK’s EU membership, which may take place even earlier than expected, in the course of next year. While an earlier date would reduce the period of uncertainty, it also reduces the time available for negotiations with the EU on the reforms and repatriation of powers sought by the UK government.

In Moody’s view, a shorter time frame increases the risk that the UK government will not manage to secure the changes that it is seeking, which in turn may negatively influence the government’s willingness to support remaining in the EU. While the outcome of the referendum remains uncertain, Moody’s believes that a withdrawal from the EU would have negative implications for the UK’s growth prospects and — in the absence of an alternative trade arrangement with the EU that at least partly replicates the current access to the EU’s single market —would likely put pressure on the UK’s sovereign rating.

Secondly, the pace of decentralisation of fiscal powers to Scotland and other regions and cities is being accelerated and might be more comprehensive than expected earlier. While Moody’s believes that the government will likely manage to maintain a reasonably strong level of control and oversight and thus ensure that the planned devolution will not materially impact the UK’s overall fiscal strength, the extent of any risk from a move towards greater federalism to the UK government’s own balance sheet will only become apparent over time.

Learn more

Learn about the risk private debt poses to the UK economic recovery by reading this interview with Professor Steve Keen.

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About Author

Christopher Menon

Every Investor Editor Chris Menon is a financial journalist who has written regularly for national newspapers, magazines and websites about personal finance, with particular emphasis on investing.