Moody’s downgrades UK’s rating on Brexit and growth fears

London (Reuters): Ratings agency Moody’s downgraded Britain’s credit rating by a further notch on Friday, saying the government’s plans to fix the public finances had been knocked off course and Brexit would weigh on the economy.

A few hours after Prime Minister Theresa May set out plans for a new relationship with the European Union, Moody’s cut the rating to Aa2 from Aa1, underscoring the economic risks that leaving the bloc poses for the world’s fifth-biggest economy.

Britain has worked down its budget deficit from about 10% of economic output in 2010, shortly after the global financial crisis hammered the country, to 2.3% in the most recent financial year which ended in March.

But Moody’s said the outlook for public finances had weakened significantly as May’s government increasingly put into question the austerity push pursued by former prime minister David Cameron and his finance minister George Osborne.

The government responded by saying Moody’s assessment of the Brexit hit to the economy was “outdated” and that May had set out an “ambitious vision for the UK’s future relationship with the EU” in a speech earlier on Friday.

The Moody’s downgrade was made after a meeting with the government on Sept. 19 and did not reflect May’s speech on Friday, the government said.

Nonetheless, Moody’s verdict on Britain’s public finances will make for grim reading for May and her finance minister Philip Hammond.

After seven years of austerity, the government was coming under pressure to ease its squeeze on public finances and a recent relaxation of a tight public sector pay cap for police and prison workers was likely to be broadened, Moody’s said.

Furthermore, a deal struck by May with a small political party in Northern Ireland after she lost her parliamentary majority in June’s election and the dropping of plans to review costly pension increases would also weigh on the public purse.

“Overall, Moody’s expects spending to be significantly higher than under the government’s current budgetary plans,” Moody’s said.

On the tax side, it noted how the government abandoned a controversial plan to raise national insurance contributions for self-employed workers and was reliant on “highly uncertain revenue gains from tackling tax avoidance to fund tax cuts”.

As a result, the budget deficit was likely to remain at around 3-3.5% of GDP in the coming years, higher than the government’s plans to cut it below 1% of GDP by 2021/22.

That meant Britain was one of the few big European economies where the public debt ratio was likely to rise, probably peaking at about 93 percent of GDP in 2019, two years later than under the latest government plans.

Brexit hit

At the same time, budget pressures would rise as Britain’s economy slowed due to Brexit, with growth of just 1% likely next year, down from 1.8% in 2017 and not recovering to its historic trend rate over the coming years.

Moody’s said it was no longer confident that Britain would secure a replacement free trade agreement with the EU which substantially mitigated the Brexit hit.

“While the government seeks a ‘deep and comprehensive free trade agreement’ with the EU, even such a best-case scenario would not award the same access to the EU single market that the UK currently enjoys,” it said.

Britain’s government said Moody’s move brought it into line with the other major credit ratings agencies, Fitch and Standard & Poor’s.

Moody’s revised up its outlook on the country to stable from negative, meaning a further downgrade is not imminent.