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'No deal' Brexit would damage UK's economic and fiscal strength

Publication Date: 14 Sep 2018 - By Gaurav Sharma (Associate Editor ReachX) By Gaurav S.

Events Environmental, Social & Governance Macro Multi Asset Equity Fixed Income/Credit EU UK

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The UK's withdrawal from the European Union without an agreement to replace existing arrangements - a risk that has risen materially in recent months - would damage the UK economy, according to a leady rating agency. 

In a note to its clients, Moody’s expressed fears about such a scenario adding that the situation would be “credit negative” for a range sectors and debt issuers in the UK as well as wider Europe. 

"We still think the UK and the EU will eventually reach an agreement to preserve many - but not all - of their current trading arrangements, particularly around trade in goods," said Colin Ellis, Chief Credit Officer EMEA at Moody’s. 

"However, we believe the prospect of the UK leaving the EU without any agreement has risen materially. The precise impact of a 'no deal' outcome is impossible to define because both the UK and the EU would likely take swift steps to limit short-term disruption. But it would clearly pose more significant credit challenges than a negotiated exit."

In an assessment, Moody’s said the impact of a 'no deal' scenario would vary across countries, sectors and debt issuers:

• UK Sovereign: It would damage the UK's economic, fiscal and institutional strength. The immediate impact would likely be seen first in a sharp fall in the value of the British pound, leading to temporarily higher inflation and a squeeze on real wages over the two or three years following Brexit. This in turn would weigh on consumer spending and depress growth, with a risk of the UK entering recession.

• EU Sovereigns: EU countries including Ireland, the Netherlands, Cyprus and Malta could experience negative consequences, particularly in areas such as trade.

• Corporates: In the UK, it would be significantly credit negative for a number of sectors due to factors such as tariffs, the weaker pound and regulatory changes. The most severely affected sectors would be automotive, airlines, aerospace and chemicals.

• Banking: The UK banking sector's overall credit fundamentals would weaken due to lower asset quality and weaker profits. The negative impact on UK banks' asset quality and profitability would be partly mitigated by their strong solvency and liquidity.

• Insurance: Pressure on revenues and operating profits could materialise for insurers operating in the UK, as weaker economic growth may reduce demand for insurance products. 

• Sub-sovereign: Reduced immigration, a weaker economy and lower employment would put pressure on Transport for London's passenger numbers and income. It would also exacerbate challenges for UK universities which could affect student and staff recruitment.

• Structured Finance - An increase in unemployment, a squeeze on real wages constraining debt service abilities and, to a lesser extent, a lower refinancing availability would lead to higher delinquencies in consumer loan pools backing RMBS and ABS transactions.

In the event of a no-deal outcome, it would not be a foregone conclusion that the UK's credit profile would be irreparably weakened. Prompt and forthright policy action could, in principle, avoid material damage to the UK's economic and fiscal strength and therefore its credit quality. 

But the balance of risks would shift firmly to the downside. In that event, we would need to consider carefully the longer-term implications for the UK's credit profile, and how best to signal the potential weakening of the UK's credit quality while allowing a period of time to take stock of UK policymakers' response.

 

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