Fitch Ratings downgraded its outlook on the U.K. to negative due to the government's unfunded fiscal package, high levels of government debt and inflationary pressures — the second ratings agency in a week to revise its outlook downward.
The ratings agency said late Wednesday that it revised the outlook on the U.K.'s long-term foreign-currency issuer default rating to negative from stable, identifying a number of key ratings drivers.
So-called "high" ratings drivers for Fitch are the "large and unfunded fiscal package announced as part of the new government's growth plan," which Fitch said in a notice outlining its downgrade decision "could lead to a significant increase in fiscal deficits over the medium term."
The government's energy price cap proposal for households and businesses equates to £60 billion ($68.3 billion), or 2.4% of 2022 GDP, over a six-month period. Changes to tax policy will also reduce revenue, according to government estimates, by £27.7 billion in fiscal-year 2023-24, and by £31.3 billion in fiscal-year 2024-25.
Fitch warned that, without "compensatory measures," the U.K. government deficit will remain elevated at 7.8% of GDP this year, increasing to 8.8% next year. That figure is expected to ease slightly in 2024, to 7.2%.
Another high driver is the change in fiscal policies expected to push general government debt to 109% of GDP in 2024, up from an estimated 101% this year. The forecast reflects higher primary deficits and a weaker growth outlook.
Increased policy uncertainty was also identified as a high driver of the rating downgrade.
Fitch said the risk of prolonged inflationary pressures was a "medium" driver, with inflation forecasts at 8.9% for this year, before gradually reducing to 4% in 2024. The ratings agency's end-2024 inflation forecast of 3.5% is above the Bank of England's target of 2%, the notice said.
Fitch affirmed the U.K.'s issuer default rating at AA-. It said medium drivers of this rating — which is unchanged, albeit with a now-negative outlook — are weaker growth prospects, with an expectation of an economic contraction of 1% in 2023; strong financing flexibility but a high current account deficit; and political uncertainty.
The ratings agency also warned that failure to implement a credible fiscal strategy that restores market confidence and is consistent with government debt or GDP declining over the medium term could lead to a negative rating action. "Evidence that policy uncertainty and/or new trading arrangements with the EU will undermine the U.K.'s macroeconomic performance and financial stability over time" is another issue that may lead to further downgrades, as well as "political developments that lead to deterioration in governance indicators and/or undermine the territorial integrity of the U.K.," Fitch said.
Upgrades or positive rating actions could be seen if a "credible fiscal strategy that is consistent with government debt/GDP declining over the medium term" is implemented, or reduced risks to macrofinancial stability.
Fitch also revised the Bank of England's outlook to negative from stable, noting that the outlook is directly aligned with the U.K. sovereign situation.
On Sept. 30, ratings agency S&P Global downgraded its outlook on the U.K. to negative from stable "on rising fiscal risks."
The pound sterling dropped 0.72% early Thursday to $1.12.
