December 6, 2012 / 5:15 PM / 5 years ago

UK government heading for political blow from debt downgrade

* Bleaker outlook raises questions over UK's top rating
    * Analysts: Downgrade worse for politicians than economy
    * Fitch says UK credibility weaker after budget update
    * Britain to miss debt-cutting goal, extend austerity

    By Peter Griffiths
    LONDON, Dec 6 (Reuters) - Britain is lurching closer to an
embarrassing loss of its prized triple-A credit rating as the
economic outlook darkens, and the political pain for Prime
Minister David Cameron's government from a once-unthinkable move
may exceed the economic damage.
    Finance minister George Osborne warned of weaker growth and
more austerity in a budget update on Wednesday. Although he
avoided the political mis-steps for which the media lambasted
him after March's budget, there now looms the more menacing
spectre of a downgrade before an election due in 2015.   
    Ratings agency Fitch said his admission that he will miss a
key debt-cutting goal weakened his fiscal credibility. That
fuelled fears Britain may be stripped of a top credit rating
that has arguably helped keep borrowing costs at record lows.
    Losing that crown would be a blow to Osborne and Cameron,
who have staked their reputations on rebuilding an economy that
suffered its biggest shock since World War Two during the
financial crisis.
    Their Conservative Party was forced to share power with
Liberal Democrat rivals after the election in 2010, and the
party's leaders had hoped to win a full mandate from voters by
proving their economic credentials. 
    They have repeatedly held up the triple-A rating as a
vindication of their flagship policy to cut the deficit and
retain the markets' confidence.
    "It is a political virility symbol," said Jonathan Tonge,
professor of politics at the University of Liverpool in
northwest England. "It is hard to overstate the political
significance if Osborne loses the triple-A rating.
    "Osborne has invested so much political capital in this
triple-A rating. In economic terms, losing it would not be
catastrophic, it would be slightly more expensive to borrow. But
it's the politics of it that count."
    Britain has hung on to its top rating since 1978, towards
the end of a decade which saw its economy blighted by the oil
crisis, industrial upheaval and double-digit inflation.
    While a downgrade would be politically damaging, analysts
said the economic impact may not be as great as once feared.
    "There are so few countries left now with a AAA rating, that
to lose it would not be the stigma or threat to market
confidence that it would have been a couple of years ago," said
Howard Archer, economist at IHS Global Insight.
    "While this would likely be seen as an embarrassment for the
government... this would actually have little negative impact
for the economy."
    Standard & Poor's removed its top rating from the United
States in August 2011. France, Japan and China are other
countries that do not have triple-A status with the agency.
    Yet borrowing costs in many of those countries remain rooted
near all-time low levels, as investors steer clear of trouble in
 indebted Southern European states and riskier emerging markets.
    
    DEBT PRESSURE
    Despite a bleak outlook, analysts said Britain was in better
shape than some other major economies.
    "The UK has neither the political risk facing the United
States nor the structural rigidities and external debt pressures
facing France," said Lena Komileva, economist at G+ Economics,
adding that many countries which formerly had AAA ratings were
now rated a shade lower at AA. 
    Analysts at Lloyds welcomed Osborne's decision to limit
further austerity measures and said the muted reaction to his
budget update in the financial markets suggested he had handled
a difficult balancing act well and could even avoid a downgrade.
    Resisting renewed calls to change course, Osborne said on
Thursday that markets were less worried about a UK downgrade
than Britain borrowing more and failing to tackle a deficit left
by the last Labour government.
    "My critics are saying Britain has got a debt problem, let's
add to the debt," Osborne told the BBC. "It doesn't make sense
and it is exactly the kind of something-for-nothing economics
that got us into this mess in the first place."
    Osborne appears to have escaped the public roasting that
followed his March budget, which started a slump in his party's
fortunes that it has struggled to turn around.   
    The Financial Times said Osborne was walking a tightrope on
the public finances, but "could have been more radical" with
bolder growth measures.
    However, the Independent was more critical, devoting its
entire front page to a cartoon showing a malevolent Osborne
dressed as a magician, pulling a rabbit's skeleton out of a hat,
with the headline "Osborne runs out of tricks".
    Others were also less sanguine about the economic effect of
a downgrade, warning that sentiment towards Britain was fragile
and could swiftly deteriorate.
    "The triple-A rating is everything. It is what has supported
sterling from selling off over the last few years and if that
were to go you would see gilt yields rising and sterling
dropping like a stone," said Christian Lawrence, currency
strategist at Rabobank. 
    But it remains likely that it will be the political fallout
that has the longer lasting effect, with the opposition Labour
Party - which leads Cameron's Conservatives by around 10 points
in the polls - ready to seize on a move by the ratings agencies
if it were to occur.
    "George Osborne is a Chancellor in the last chance saloon,
Labour finance spokesman told BBC radio on Thursday. "His
judgements have been so woeful and so wrong."

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