MNI EXCLUSIVE INTERVIEW: DBRS Sees UK Flexibility Underpin AAA

--UK Flexible Enough For 'AAA' Post-Brexit: DBRS

--Brexit Outcome, Constitutional Integrity Key for UK Rating 

--Fiscal Deterioration Closely Watched, Not Current Concern

By Jamie Satchithanantham

     LONDON (MNI) - Unless there is a wide-scale deterioration in institutional

and structural factors, the UK's 'AAA' credit rating will likely not come under

threat, despite fresh challenges thrown up by the ongoing Brexit negotiations

and softer economic growth, a senior sovereign debt strategist at a leading

credit ratings agency has told Market News International.

     In an exclusive interview with MNI, Nichola James, Co-Head of Sovereign

Debt at ratings agency DBRS, said that the UK has enough flexibility to "to be

able to deal with whatever economic headwinds come its way", as was demonstrated

in aftermath of the financial crisis. 

     DBRS rated the UK at 'AAA' since 2013, when it commenced rating the UK,

owing to flexibility among key institutional and structural factors. These key

factors ranged from the UK's rule of law, which James stressed to be crucial in

their methodology, the independence of both the Bank of England and the Office

of Budget and Responsibility, as well as the flexibility in the UK's labour

market.

     For James, the fact that these factors remain intact continue to provide

comfort that any potential headwinds thrown up by Brexit or a slowdown in output

growth could be "managed". 

     The slow progress of divorce proceedings so far between Britain and the

European Union has meant the likelihood of a softer Brexit is now stronger, with

the notion of a transitional deal after the March 2019 Brexit deadline gaining

traction among both UK and EU officials. 

     Earlier this week, Guy Verhofstadt, the European Parliament's Brexit point

man, said that there was a "greater understanding from the UK side for the need

for a transitional arrangement".

     "The more and more time we lose in the coming months, the more and more it

is clear that the transition period can only be the prolongation of the existing

situation, the status quo," he added.

     When asked if the rating would come under threat in the 'no transitional

deal' scenario, James ultimately believed an agreement would be found by March

2019 given it was in the interests of both parties.  

     "Ultimately, arrangements will be made that will be reasonable outcomes for

the UK and the EU because it's very easy to forget that the EU also has a vested

interest in arrangements," said James. 

     "We were disappointed that there hadn't been more progress made because the

clock is ticking, but we're not going to get hung up in our ratings if these

negotiations are sparky and if it looks like they go on until 'midnight'," she

added.

     The most recent confirmation of DBRS' UK AAA rating came in June after the

result of the general election, which was viewed as ratings positive --

particularly due to the apparent weaker support for an independent Scotland.

     "One of the elements was the Scottish vote. It indicated that the

independence cohort was less strong and that in fact is one of our key ratings

drivers - that the UK remains in its present form," said James.

     "The other sense was that Theresa May may have to consider a more flexible

approach to Brexit negotiations rather than the very hard approach she had in

her stride prior to the elections," she added.

     Looking forward to the next UK rating assessment, James said there are

three rating drivers they will consider, "one is related to Brexit, contingent

on the outcome, the other are constitutional integrity and fiscal deterioration

for whatever reason -- Brexit or something else".

     In line with her stance on Scotland, James also highlighted the importance

for political stability in Northern Ireland post-Brexit. 

     "Obviously, the open border has been supportive of the rating and

supportive of the peace agreement and we are concerned about the possibility of

a hard border there -- more I think on the political side than on the trade

side," said James.

     "That feeds into one of the ratings drivers, the integrity of the UK, and

if there was any risk to the political situation in Ireland that could

potentially put downward pressure on the rating," she added.

     On other threats to the rating, James acknowledged the UK's twin deficit,

the current account and budget deficits, saying that they would be monitoring

flows of foreign investment coming into the UK but remained calm on account of

the UK's flexible exchange rate. 

     "What we're going to be looking for going into the negotiations and the

outcome of the EU exit is the appetite for FDI in the UK because, obviously,

there's an offset between the current account and the capital account so we will

be monitoring flows but provided the exchange rate takes the hit it wouldn't

necessarily impact the rating," she said. 

     Regarding the fiscal deficit, James said she was satisfied with the

Treasury's objectives and assumptions laid out thus far, adding she was instead

"concerned with the medium term and beyond", that is meeting the demographical

challenges the UK faces.  

     As for UK growth in 2017, groups ranging from the OBR and the Bank of

England to the IMF and European Commission have all placed it somewhere in the

1.5%-2.0% range. 

     James believed this was "pushing it a little bit, given the outturn that

we've had already". UK growth was confirmed at 0.3% q/q in Q2, up 0.1pp from

0.2% q/q in Q1, considerably lower than the growth of 0.7% q/q recorded in the

final quarter of 2016.

     Should growth continue to underwhelm, "certainly, that could make the

fiscal deterioration a little bit bigger this year but that by itself wouldn't

lead us to downgrade," said James.

     "I'm not expecting those forecasts to be achieved this year, if they are it

could be a bonus. I would imagine growth would be slower but there could be

potential for growth next year," she added.    

     At present, DBRS is the only agency to rate the UK 'AAA'. Standard and

Poor's, along with Fitch Ratings, currently rank the UK 'AA', with Moody's

Investor Services at 'Aa1'. All three have the UK on a negative outlook, while

DBRS currently maintain a stable outlook. 

--MNI London Bureau; +44 203-586-2226; email: jamie.satchithanantham@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

[TOPICS: M$B$$$,M$E$$$,MC$$$$,MI$$$$,MR$$$$,MX$$$$,M$$CR$,MGB$$$]