SOVEREIGN AND SUPRANATIONALSECTOR IN-DEPTH 4 April 2016ContactsIrina Baron Asst Dir-Research Associate irina.baron@moodys.comXian Li 212-553-1404Senior Research Analyst xian.li@moodys.comABOUT CAPITAL MARKETS RESEARCHAnalyses from Moodys Capital Markets Research, Inc. (CMR) focus on explaining signals from the credit and equity markets. The publications address whether market signals, in the opinion of the groups analysts, accurately reflect the risks and investment opportunities associated with issuers and sectors. CMR research thus complements the fundamentally-oriented research offered by Moodys Investors Service (MIS), the rating agency.CMR is part of Moodys Analytics, which is one of the two operating businesses of Moodys Corporation. Moodys Analytics (including CMR) is legally and organizationally separated from Moodys Investors Service and operates on an arms length basis from the ratings business. CMR does not provide investment advisory services or products.View the CMR FAQ Contact the CMR team Follow us on TwitterMoodys Analytics markets and distributes all Moodys Capital Markets Research, Inc. materials. Moodys Capital Markets Research,Inc. is a subsidiary of Moodys Corporation. Moodys Analytics does not provide investment advisory services or products.For further detail, please see the last page.Sovereign Risk ReportBrexit Uncertainty Keeps UK Sovereign Credit Risk ElevatedMarket-based probability of default measures for the United Kingdom remain elevated as uncertainty surrounding the June 23 European Union (EU) referendum lingers. The UKs five-year Sovereign EDFTM (Expected Default Frequency)1 measure has more than doubled since October, rising from 0.029% to its current 0.081% (see Figure 1). Over the past week the countrys credit risk eased somewhat, as it joined the global rally sparked by Federal Reserve Chair Janet Yellens speech on Tuesday suggesting a slower path for future rate increases. All but nine countries in our dataset recorded a decline in their probability of default measures.The prolonged rise in the UKs Sovereign EDF measure reflects investors concerns over the potential economic and financial market upheaval from the UK exiting the EU. The Bank of England voiced concerns over the past week that a vote to leave the EU may reduce foreign investment and increase borrowing costs. This is particularly troublesome, as the UKs Office for National Statistics (ONS) reported a widening in the countrys current account deficit from ª92.9 billion in 2014 to ª97.3 billion in 2015. Banking is a systemically important sector because the supply of credit is a key component of economic activity. As shown on Figure 1, changes in the probability of default in the UK have been highly correlated with changes in the probability of default of the countrys three largest banks2 since 2013 (correlation 0.65 over this period). Moreover, the rise in the countrys EDF measure preceded the rise in the cred...
