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United Kingdom: Deal With EU Reduces Uncertainty and Supports Growth Outlook

By:
Eiko Sievert
Published: Mar 6, 2023, 16:10 UTC

The Windsor Framework agreed between the EU and UK is an opportunity for the UK to reduce uncertainty and unlock investment, which is crucial for the country’s growth prospects.

United Kingdom: Deal With EU Reduces Uncertainty and Supports Growth Outlook

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The resolution of political tensions with the EU related to the Northern Ireland Protocol is likely to open new opportunities for increased cooperation between the UK and its largest trading partner, supporting Scope Ratings’ AA/Stable ratings for the United Kingdom.

Following several years of elevated political uncertainty, a more stable, predictable and constructive policy environment is now slowly emerging. This is in line with our rating approach, which has looked through the short-term policy volatility caused by the market turmoil following the mini-budget in September 2022 (Figure 1).

Figure 1: UK sovereign rating history

Note: Ratings are converted into Scope’s rating scale based on an alpha-numeric conversion on a 20-point scale from AAA (20) to D (1). Negative/Positive Outlooks are treated with a +/-0.33 adjustment. Reviews for upgrades/downgrades are reflected via a +/-0.67 adjustment. Source: Scope Ratings.

Less Volatile Policy Environment Positive for Growth Outlook

While the implementation of the Windsor Framework will not be without its challenges and further concessions may be needed by both sides to reach a final agreement, we believe this could set the stage for more constructive negotiations on financial services, renewed participation in the EU’s Horizon Europe research and innovation programme, as well as closer collaboration on security issues.

On this basis, as the relationship with the EU stabilises and the UK re-builds its reputation as a reliable negotiating partner, it may also help efforts to finalise trade talks such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership in the near future.

The gradual shift towards a more predictable and stable policy environment is likely to be welcomed by investors and businesses, who may have previously been deterred by the UK’s uncertain political landscape.

Such developments should be positive for the UK’s anticipated weak economic outlook over the coming years. After a 0.6% contraction of GDP expected in 2023, we expect the UK to grow only by 1.1% in 2024.

The country faces considerable near-term challenges including weak productivity, stagnating levels of business investment and lagging labour-market participation, curbing the UK’s growth potential, which the Bank of England now estimates at less than 1%.

Higher Growth Needed to Support Country’s Public Finances

Government borrowing is likely to be around GBP30-40bn lower than previously expected largely thanks to falling energy prices in recent months, lower government bond yields and higher-than-expected tax revenues.

This, however, does not imply that the government has significantly increased its headroom to ease fiscal policy. High inflationary pressures and rising interest rates have worsened the cost-of-living crisis, resulting in widespread public sector strikes.

The tax burden is expected to peak at a post-World War II high of 37.5% of GDP in 2024-25 and the country will face challenging trade-offs between higher future taxes or a lower level of public services. Such structural challenges are particularly visible in the healthcare sector. Long-term healthcare spending estimates until 2050 suggest that the UK will face one of the steepest increases in related spending in Europe (Figure 2). Therefore, the pressure for fundamental reform in the healthcare sector and other public services will only increase.

The UK will have to balance its future spending needs with the reality of its current fiscal situation. This will require the prioritisation of public spending to ensure the sustainability of public services while also managing high levels of debt and deficits. We expect continued government deficits in the UK with debt-to-GDP reaching 101% by 2025. While this exceeds debt ratios in higher-rated economies such as AAA-rated Germany (64%), it is expected to remain below that of other AA-rated countries such as the United States (126%) and France (114%).

Figure 2: Net present value of healthcare spending change, 2021-50, % of GDP

Source: IMF, Scope Ratings

By improving its political relationship with the EU and rebuilding its international reputation, the UK can increase its medium-term prospects. The country’s strong institutional framework provides a solid foundation for navigating these challenges while preserving fiscal credibility.

For a look at all of today’s economic events, check out our economic calendar.

Eiko Sievert is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH.

About the Author

Eiko Sievertcontributor

Eiko Sievert is a Director in Scope’s Sovereign & Public Sector ratings group, responsible for ratings and research on a number of sovereign and supranational borrowers.

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