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

Fitch has maintained the UK's sovereign credit rating at a healthy AA- grade, despite warning that rising energy prices would slow economic growth and contribute to inflation. The UK, Europe's second-largest economy, retained its AA- rating due to its high-income, large, diversified, and flexible economy, as well as its versatile financial markets and the pound's status as an international reserve currency.

An AA- rating is the fourth-highest on Fitch's scale, only three notches below the top prime grade, granting the UK easier access to capital markets for borrowing.

However, Fitch predicts a slowdown in UK economic growth, with real gross domestic product growth expected to be 0.9% this year and 1.2% in 2027, lower than the agency's February projections. Tightening funding conditions and a weak labor market are also cited as contributing factors to the slower growth. In June, despite the Iran war's ripple effects, Britain's economy saw a surprise 0.3% increase in growth.

Inflation is expected to rise from 2.6% in June to 3.7% by the end of the year, primarily due to high energy costs, before retreating to 2% by the end of 2028 in line with the Bank of England's target. The Bank of England kept its key interest rate at 3.75% last month, warning that inflation could reach 4% at the start of 2027, followed by a series of cuts to bring it down to 3% by 2028.

Fitch noted Britain's credible macroeconomic policy framework, which is not expected to change significantly under Prime Minister Andy Burnham, who succeeded Keir Starmer recently. There is little expectation of a substantial near-term change to fiscal rules or macro-policy, as stated by analysts at Fitch. Burnham's tenure as UK's prime minister has been marked by questions regarding his approach to handling the economy, including ensuring fiscal discipline.

Fitch expects the UK government to maintain fiscal policy credibility, largely due to financial market constraints and the potential for rising gilt yields to damage the new leadership's economic credibility.