Moody’s says it may cut outlook on Aa1

If the UK were to leave the EU, the credit impact for the sovereign and the implications for its rating would depend primarily on what new trade arrangements the UK government could achieve, as well as its other economic policy choices, according to Moody’s Investors Service.

The rating agency added it might assign a negative outlook to the Aa1 in the event of a vote to withdraw from the EU, to reflect its view that exit would have negative consequences for the UK economy and hence potentially for the UK’s credit strength.

“Exit would be negative for trade and investment in the UK, given the close links with the EU as the UK’s single most important trading partner and largest source of foreign-direct investment,” said Kathrin Muehlbronner, a Senior Vice President at Moody’s. “These outweigh the benefits from exit such as cost savings for government and a reduced regulatory burden for businesses in our view,” she added.

However, rather than the short-term impact on growth, Moody’s would focus on the medium term economic and political impact of an exit. In the rating agency’s view, exit from the EU would not provide immediate clarification on the UK’s future trade and economic prospects. Instead, it would likely be the beginning of potentially multiple, lengthy and complex negotiations on a new trade agreement with the EU that conserves at least part of the benefits that EU membership affords.

“The UK could face a potentially prolonged period of uncertainty, which in itself would be damaging to confidence and investment. A Swiss-style series of bilateral agreements or a comprehensive free trade agreement would invariably take time to negotiate and this process wouldn’t be easy,” said Muehlbronner. According to EU legislation, effective withdrawal from the EU could take up to two years, during which the outline of an alternative arrangement would likely emerge. In addition to negotiating with the EU on a new trade deal, the UK authorities would probably have to renegotiate other bilateral and multilateral free trade agreements that the UK currently benefits from as an EU member state.

The UK might also reconsider other domestic policies, such as banking regulation, in order to limit the impact on the financial services sector. While Moody’s considers the UK’s institutional strength to be very high, exit and the associated challenges would place a significant burden on policy-makers and the agency would monitor the implications for the effectiveness of policymaking very closely.

These challenges would likely outweigh the economic benefits of exit, according to Moody’s. The cost savings on the government’s contributions to the EU budget are modest at around 0.6% of GDP per annum and in the rating agency’s view UK-based businesses would continue to have to comply with EU regulation even after exit, if they wanted to sell into the Single Market.

Moody’s also noted that EU regulation has not impeded the UK’s flexible labour and product markets, nor does the EU seem to be a key constraining factor for extra-EU trade, as Germany’ strong trade links with China and other emerging markets show.

The EU accounts for around 50% of UK goods exports and 37% of services exports (2014 data). Last year, the UK received net foreign-direct investment (FDI) of GBP 44 bln, which equates to around a third of all EU investment inflows, with many investments from outside of the EU attracted to the UK as an entry point to the larger EU market.