UK retains high Fitch rating, but rising energy prices set to tame economic growth

Fitch has maintained the United Kingdom's sovereign credit rating at a solid AA- rating, despite recognizing that escalating energy prices will dampen economic growth and fuel inflation. The UK, the second-largest economy in Europe, boasts a high-income, large, diverse, and adaptable economy, bolstered by its versatile financial markets and the pound's status as an international reserve currency, according to the New York-based credit rating agency.

An AA- rating places the UK three notches below the top prime grade on Fitch's scale, granting it access to capital markets and the ability to raise funding when borrowing is necessary. Nonetheless, the agency anticipates that high and volatile energy prices, stemming from ongoing Middle East tensions in the Iran war, will impact the UK economy.

Real gross domestic product growth is forecast at 0.9 percent this year and 1.2 percent in 2027, slower than the initial projections in February, with tighter funding conditions and a weak labor market cited as contributing factors.

In June, Britain's economy experienced an unexpected 0.3 percent growth, despite the fallout from the Iran war. Fitch indicates that risks to growth remain balanced, with potential upside from faster progress on public investment plans, wider artificial intelligence adoption, or broader EU trade integration beyond current negotiations.

However, inflation is projected to rise from 2.6 percent in June to 3.7 percent by year-end, primarily due to soaring energy costs, before easing to 2 percent by the end of 2028, in line with the Bank of England's target. The central bank recently held its key interest rate at 3.75 percent, warning that inflation would reach 4 percent at the start of 2027, with multiple cuts anticipated to reduce it to 3 percent by 2028.

Fitch highlighted the UK's credible macroeconomic policy framework, which is expected to remain largely unchanged under Prime Minister Andy Burnham, who assumed office from Keir Starmer last month. The new administration's fiscal rules and macroeconomic policies are not anticipated to undergo substantial changes, consistent with Burnham and Chancellor John Healey's statements. However, analysts at Fitch foresee increased fiscal policy uncertainty as the country approaches the next election.

Prime Minister Burnham, the UK's sixth prime minister in the past decade, took office amid concerns about managing the economy, including maintaining fiscal discipline. Fitch's expectation that fiscal policy will not be significantly relaxed largely stems from financial market constraints, as rising gilt yields could undermine the economic credibility of the new leadership.

Heightened focus on fiscal rules to anchor policy reflects efforts to counteract higher spending pressures from elements of the Labour Party and the growing credibility of these rules, which moderately reduces the ability to delay necessary fiscal adjustments.