Bond market research specialist DBRS has said that it views the draft Brexit withdrawal agreement as a positive sign that the authorities have reached the next big step in the process.
Despite the significant risk that the newly released withdrawal agreement between the European Union (EU) and the UK negotiators will not be ratified, DBRS said Friday that the credit fundamentals underpinning the UK’s AAA ratings for UK gilts remain unchanged.
The withdrawal agreement must next be approved by the 27 EU leaders at the European Council summit scheduled for 25 November, then ratified by the UK parliament and the European Parliament. If approved, the draft agreement will become the legal basis for Britain’s departure from the European Union. In the draft agreement, the UK would remain in a ‘customs territory’ with the EU to avoid a hard border between the Republic of Ireland and Northern Ireland until a permanent solution is found.
- Investing in government bonds
- Robowise launches automated corporate bond trading for retail investors
- The Brexit impact on financial markets
- Learn about the UK 10 year gilt
Recent political volatility – including key cabinet resignations – is not surprising, and DBRS says it expects more volatility over the near-term.
Following months of difficult discussions, the presentation of the withdrawal agreement allows the UK and EU parliaments to have the final word on the terms of the UK’s departure from the EU. DBRS said it does not rule out any of the possible scenarios ranging from: successful ratification of the withdrawal agreement (soft Brexit) to unsuccessful ratification with no alternative arrangements (hard Brexit).
“It is possible that in the coming days or months the government could face a conservative party leadership challenge, be forced to call a general election or hold a second Brexit referendum,” DBRS said in a statement issued on Friday. “Over the longer term, Brexit could ultimately jeopardize the cohesion and resilience of the United Kingdom – one of the main risks that could affect the UK’s credit rating. Significant uncertainty remains over different regulatory and customs regimes between Northern Ireland and the mainland, and how this might impact the UK.”
For the time being, DBRS sees little evidence that the increased uncertainty has materially weakened the UK’s credit fundamentals. The UK’s ratings are underpinned by the size and resilience of the British economy and financial markets. HM Treasury and the Bank of England (BoE) oversee one of the world’s primary currencies and reserve assets.
Flexible exchange rate key support for UK gilts
DBRS considers the UK’s flexible exchange rate an important shock absorber and the global benchmark UK government bonds facilitate low-cost local currency borrowing across a broad range of maturities. This capability is particularly valuable during periods of investor risk aversion, which was evident in declining bond yields in recent weeks when Brexit negotiations appeared most protracted. The UK’s very favourable maturity structure of public debt is another key credit strength.
DBRS said it expects the UK gilts’ credit fundamentals to remain intact in the near term but will carry on evaluating the impact of Brexit and the associated period of political uncertainty.
The ratings could come under downward pressure from one of the following factors or a combination of these factors:
- A Brexit outcome that materially diminishes economic resilience and erodes the government’s debt financing flexibility;
- Economic and financial dislocations that deteriorate banking sector fundamentals or the country’s fiscal position;
- A significant increase in the likelihood of a break-up of the United Kingdom.
