UPDATE 3-Fitch backs away from downgrade of U.S. credit rating

Mon Jan 28, 2013 1:26pm EST

By Luciana Lopez

NEW YORK Jan 28 (Reuters) - Rating agency Fitch on Monday stepped back from its threat to cut the United State's triple-A credit rating in the next few months, citing the recent debt deal in Washington, in the latest sign that anxieties have eased over another drawn-out budget battle.

The stock market has rallied in recent days, with the benchmark S&P 500 index hitting a five-year high last week as the progress in Washington has driven investors back into riskier assets.

With lawmakers now free of "the distraction of a near-term funding crisis," Fitch said policymakers now "have the space to focus on the substantive fiscal policy choices."

Nevertheless, Fitch warned that the United States could still face a debt downgrade if policymakers don't pull together a "credible" plan to reduce the country's massive deficit over the medium term, which it defines as six to 12 months.

Fitch is not alone in still harboring concerns.

Moody's Investors Service has a negative outlook on its U.S. rating, which it still has at a top Aaa. And Standard & Poor's has left its rating at AA-plus since downgrading it from triple-A after Washington's debt standoff of August 2011, albeit also with a negative outlook.

Congress last week reached a deal to let the U.S. government continue to borrow money through mid-May, sidestepping the threat of reaching the limits of the country's borrowing capacity, something that could have triggered a technical default. Recent signals from lawmakers suggest another round of bruising debt debates is now unlikely.

"I don't see a blatant act right now that would warrant a downgrade," said Greg Valliere, chief political strategist at Potomac Research Group, which advises institutional investors on Washington politics.

"I think it's highly unlikely that there's going to be a show-down over the debt ceiling. The Republicans have realized it would not help them politically," he added.

Fitch's announcement on Monday comes after it warned for months around the need for policymakers not to reprise August 2011, when the normally routine business of raising the debt ceiling turned into a nasty budget battle that brought the government to the brink of default.

DOWNGRADE STILL POSSIBLE

Nervousness remains about coming fiscal battles, including a scheduled series of spending cuts that Congress had put off at the start of this year. Ratings agencies may still move to cut the U.S. rating due to worry about the health of the world's biggest economy.

When Standard & Poor's cut its rating on the United States to AA-plus from AAA in August 2011 it specifically cited the political intransigence on display.

The rating cut, however, did little to cool investor ardor for Treasuries, with yields, which move inversely to prices, falling to record lows less than a year later as the global economy remained gloomy.

Another rating downgrade could further erode already-low opinions of Congress, said Douglas Elliott, a fellow at the Brookings Institution.

"The public views a downgrade of the U.S. debt rating as just one more sign that the government doesn't know what it's doing," he said.

After the need to raise the debt ceiling again threatened to turn into a round of fractious finger-pointing in Washington this month, the U.S. House of Representatives agreed to suspend limits on the government's ability to borrow until May 19.

The agreement does not specify a dollar amount for any debt ceiling increase, but allows borrowing as needed to meet federal obligations that must be paid by that date.

While the government could still face a shutdown, and the automatic spending cuts known as sequestration could still take effect, analysts said the United States may have sidestepped the worst of their fiscal fears this year.

Moody's said that with its negative outlook on the U.S. debt rating, it is particularly looking for improvement in the ratio of the country's debt to gross domestic product, and the trajectory of the debt.

Fitch itself said a downgrade was still likely later in the year if Washington failed to use the new breathing space to put in place a credible debt reduction plan.

"I think a lot of the bluster has diminished on debt issues," said Valliere of Potomac Research. "Both parties are showing signs of working together."

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