The UK faces a further post-Brexit credit-rating downgrade if the government is not able to preserve core elements of the country’s current single market access with the European Union, Moody’s says in its annual UK credit analysis report.
The ratings agency also revised its forecast for the UK’s GDP growth in the short term from 1.8 per cent in 2016 and 2.1 per cent in 2017 to 1.5 per cent and 1 per cent respectively.
Medium-term growth would be dependent on the UK’s trading relationship with the EU, with the economy expected to bounce back to its historic average of around 2 per cent from 2019 onwards if it is able to safeguard the country’s existing trade benefits. This would halve to 1 per cent if it reverts to trading with the EU and other countries under WTO rules.
Moody’s says it did not expect the UK’s GDP to benefit from leaving the European Union, as the upside from negotiating free trade agreements with large economies like India and China would be limited due to their lack of demand for sophisticated services exports compared to advanced economies like the EU.
Moody’s downgraded the UK’s credit rating the day the outcome of the Brexit vote was delivered to Aa1 negative, but says the nature of the UK’s relationship with the EU will impact its creditworthiness in the medium term.
The UK will likely conclude negotiations on its exit from the EU via Article 50 in early 2019, following a two-year negotiation period, Moody’s believes. But it added the negotiations on its new trading relationship were likely to take much longer than the formal withdrawal process.
Its base case is that the UK faces additional “but manageable” requirements to trade with the EU, such as customs checks, rule of origin and licensing requirements, and that it might also be required to contribute to the EU budget.
It expects the City of London to remain a financial services hub, but that some banks may move services if passporting rights are lost, leading to employment losses in the UK and additional costs for affected companies.
The report points out the UK is a predominantly service-based economy, with services activities accounting for 80 per cent of gross added value, compared to manufacturing, which accounts for 9.8 per cent.
The report also pointed out that sophisticated service offerings, in legal, professional and marketing, were less price sensitive than goods and were therefore unlikely to benefit so much from the approximately 10 per cent drop in sterling following the referendum vote.
The report outlines four possible alternative trading arrangements the UK could negotiate with the EU based on Norway, Switzerland and Canada’s existing relationships, as well as the worst-case scenario in which the EU and UK traded under WTO rules.
Only the Norwegian option, whereby the UK would remain part of the European Economic Area, would offer full access to the EU single market. However, it would also mean the free movement of people and significant contributions to the EU budget, which were contentious issues for the Leave campaign in the run up to the Brexit vote.
The Swiss bilateral free-trade agreement model would also involve the free movement of people, but would require a smaller contribution to the EU budget than for EEA countries. In this scenario, the UK would have limited access to the EU for financial services.
The Canadian model, which Brexit minister David Davis has touted as his preferred model, would involve no free movement of people, but would also see limited tariffs on goods as well as no free access for services.
Canadian trade minister Chrystia Freeland has previously said her country’s deal, due to be ratified next year following seven years of negotiation, offered “ambitious services agreements” but could not match the passporting rights that the UK currently enjoys as a member of the EU.
The UK would lose its access to 50 existing free trade agreements it enjoys as a member of the EU in every scenario.