Britain's prized triple-A credit rating came under fresh threat on Thursday, after ratings agency Standard & Poor's cut its outlook for UK government debt to negative.
S&P sees a one-in-three chance that Britain will lose its triple-A rating, which would be a major embarrassment for finance minister George Osborne, who has staked his reputation on strengthening Britain's public finances.
"The outlook revision reflects our view that we could lower the ratings on the UK within the next two years if fiscal performance weakens beyond our current expectations," S&P said.
"We believe this could occur in particular as a result of a delayed and uneven economic recovery, or a weakening of political commitment to consolidation," it added.
Much weaker official growth forecasts forced Osborne last week to abandon a pledge to put Britain's net debt as a share of national income on a downward path by 2015, and S&P cited rising debt as a key reason for its negative outlook.
S&P had been the last major rating agency to hold a stable rating on British debt, after the other two, Moody's and Fitch, gave negative outlooks early in 2012 to their triple-A ratings.
"2013 looks like being a year when the UK could lose its AAA rating fairly comprehensively," said BNP Paribas economist David Tinsley. "Some of the safe-haven glow of the UK is looking a bit tarnished."
Moody's has said it will review its rating in the first few months of next year, while Fitch has said it would take another look after Osborne's March 20 budget.
Britain expects to run a budget deficit of 7 percent of gross domestic product this year, down from 11 percent at the height of the financial crisis. But it forecasts net debt, excluding financial sector interventions, will continue rising and peak at 80 percent in the 2015/16 tax year.
MARKET IMPACT UNCLEAR
While losing the triple-A rating would be a political blow to Osborne, the market impact on Britain's borrowing costs would be less certain. The United States and France both lost their triple-A ratings after the financial crisis, and later saw their bond yields plumb fresh record lows.
Britain, Germany and Canada are the only major economies to retain a triple-A debt rating.
Nonetheless, some investors are already edging away from British government debt. British government bonds' yield premium over safe-haven German debt rose to its highest since October 2011 earlier on Thursday, before S&P made its announcement.
"You have seen this death of a thousand cuts, a sort of salami-slicing of the gilt market," said Andrew Roberts, a fixed income strategist at Royal Bank of Scotland.
Britain's finance ministry stressed that S&P backed the country's current deficit-reduction plan.
"Standard & Poor's endorse the government's 'strong commitment to implementing the fiscal mandate' and specifically warn against slowing 'the pace and extent of fiscal consolidation'. It is because we have stuck to that commitment that the deficit is down," a spokesman said.
However, the opposition Labour Party said the rapid pace of government spending cuts was self-defeating as it reduced economic growth.
"At the start of this year S&P warned that austerity alone risks becoming self-defeating. But even as that warning is coming true, George Osborne is refusing to listen," said senior Labour Party lawmaker Ed Balls.