UK faces ratings downgrade if Brexit leads to a bad trade deal with the EU, says Moody’s

Theresa May needs to keep Britain as open as possible to EU trade if she wants the economy to stay strong, according to a new study from credit ratings agency Moody’s.

A weak deal which gives poor access to EU markets could force the agency to chop the UK’s credit rating, in a sign to international investors that Britain will grow more slowly and its public finances will become less stable.

Moody’s favours an agreement which replicates EU membership as closely as possible, such as membership of the European Economic Area – but this is unlikely to happen, as the government wants to limit migration from the EU.

The worst-case scenario is falling back on World Trade Organisation rules, which would put up tax barriers across the Channel – which Moody’s also thinks is unlikely.

Canada’s trade deal with the EU is one potential model for the UK to follow

Jennifer Jacquemart/EU

“If the UK continues to insist on an end to free movement of persons, then a trade deal similar to the one that the EU recently concluded with Canada (CETA), might be the closest template for the UK,” said  Kathrin Muehlbronner at Moody’s Investors Service.

“An agreement similar to Switzerland’s bilateral agreements would offer better EU access, but at the ‘price’ of allowing free movement of persons.”

The precise details will not be known until negotiations commence, after Article 50 is triggered by the end of March 2017.

“Once negotiations start, we expect that the spirit in which they are handled by both sides will offer important insights into the likely outcome,” said Ms Muehlbronner.

The impact will be crucial for those assessing the UK’s economic health and considering investing in the country.

“Our starting point is that the UK’s medium-term economic outlook will be weaker than it would have been otherwise. But the extent to which growth prospects will be affected depends crucially on the type of new trading relationship with the EU,” she said.

“We would downgrade the UK if we were to conclude that the arrangements likely to be put in place would not materially mitigate the negative impact on growth of leaving the EU.”

While it may be relatively straightforward to come to a free trade agreement covering most goods, a deal including services – and particularly the financial services in which Britain specialises – may be tougher.

Other potential triggers for downgrade include this month’s Autumn Statement from Chancellor Philip Hammond.

A modest, short-term increase in government spending “need not by itself trigger a downgrade, if it were limited and we were to conclude that it addressed important infrastructure bottlenecks and enhanced productivity growth,” said Ms Muehlbronner.

But a bigger spending spree could damage the credit rating “given that the UK has relatively weak public finances when compared to peers, with one of the largest budget deficits among advanced economies and a high and rising public debt ratio.”

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