The DBRS Morningstar rating was immediately welcomed by finance minister (DP), who said that it was “reassuring news in the current highly uncertain macroeconomic environment.” The announcement, which followed a similar AAA rating conformation by Fitch earlier in July was evidence of the government's responsible fiscal policy and the measures taken to strengthen the resilience of our economy,” Backes said in a statement.

DBRS Morningstar said that the ratings reflect Luxembourg’s very strong public finances. The ratings agency said that although the economy’s growth outlook has deteriorated in recent months due to increases in energy prices, while budgetary pressures have “increased moderately” as the government sought to cushion the adverse impact through fiscal support measures, the risks are mitigated by “Luxembourg’s ample fiscal space for absorbing a temporary increase in budgetary pressures” thanks to its comparatively low level of public debt.

While DBRS Morningstar does not foresee any downgrade in the triple A rating soon, it warned that “a severe shock to Luxembourg’s large international financial centre, most likely generated by sustained turmoil in financial markets” and “material damage to Luxembourg’s attractiveness as a business hub” could both have a significant impact on the economy and on public finances which could result in a review of the top rating.

The ratings agency added that Luxembourg’s economy had recovered from the covid pandemic “at a comparatively strong pace”, with real GDP growing by 6.9% in 2021. And even though a modest increase in government debt is expected over the next few years--it is forecast to rise from 24.4% at end 2021 to 26.2% in 2025--the government debt-to-GDP ratio remains among the lowest in Europe and below the country’s own ceiling of 30%.

Backes added that she believed the draft state budget for 2023--which will be presented to parliament by MP in autumn--will reflect “a fair balance between maintaining a sound budgetary trajectory and targeted measures in for those who need it most.”

Banks have good buffers

As for the financial sector, the ratings agency says that banks are profitable and have comfortable liquidity positions. “Moreover, banks benefit from good capital buffers, which are sufficient to absorb some potential weakening of asset quality in the future,” it said in its report.

On the other hand, DBRS Morningstar views a potential correction of housing prices in tandem with rising interest rates as a risk factor for banks’ asset quality. “Around 51% of total new mortgage loans extended to households between 2012 and 2021 have fixed the initial interest rate only up until one year, exposing these mortgage borrowers to increases in interest rates,” it stated.