The UK faces a possible sovereign ratings downgrade if core elements of the country's access to the European Single Market are lost following Brexit, according to Moody's.
In a note to clients on Tuesday (2 November), the agency which rates the UK as Aa1 – a notch below its highest rating – opined that the loss of single market access following Brexit had the potential to materially weaken the country's medium-term growth.
While Moody's central view is that the UK's medium-term economic outlook will in any event be weaker than it would otherwise have been, the scale of the impact of Brexit on its growth prospects will depend on "the format of the UK's new trading relationship with the EU".
Kathrin Muehlbronner, analyst and senior vice president at Moody's, said: "We would downgrade the UK's sovereign rating if the outcome of the negotiations with the EU was a loss of access to the single market.
"A second trigger for a downgrade would be if we were to conclude that the credibility of the UK's fiscal policy had been tarnished as a result of Brexit or other reasons."
The rating agency expects that the UK government's Autumn Statement, due on 23 November, will likely give significantly more clarity in this area.
Moody's current baseline expectation is that the UK will eventually manage to enter into some form of free trade agreement with the EU. One scenario it considers to be realistic is a series of accords offering access to the EU market for goods and more constrained access for services, in particular financial services. However, such an outcome is far from certain, the agency cautioned.
The government will start the exit process by March 2017 at the latest, and the agency sees "little likelihood" that the UK will not exit the EU.
"Even the withdrawal process might not be finalised within the two-year time frame set by the Lisbon Treaty. But once negotiations start, we expect that the spirit in which they are handled by both sides will offer important insights into the likely outcome," Moody's said.
In September, the agency opined that the loss of the European Banking Passport rights of UK banks that operate across EU jurisdictions would be credit negative but manageable. "The greatest impact would be felt through higher costs and increased inefficiency as the companies restructure, leading to reduced profitability for some time," Moody's concluded.