NEW YORK The United States may lose its top credit rating if next year's budget talks do not produce policies that gradually decrease the country's debt, Moody's Investors Service said on Tuesday.
The warning comes two months before national elections that may fail to loosen the current gridlock in budget policy.
Recent polls suggest that if the election were held tomorrow, President Barack Obama would win a second term while Republicans would strengthen their hold on Congress.
Moody's, which gives the United States the top Aaa credit rating but with a negative outlook, said Congress needs to put the debt level on a downward trajectory to maintain that rating.
If budget talks "lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable," Moody's said in a statement.
"If those negotiations fail to produce such policies, however, Moody's would expect to lower the rating, probably to Aa1."
The dollar fell and the euro hit a four-month high after the ratings agency's statement.
Rival ratings agency Standard & Poor's stripped the United States of its top ratings last year after Congress failed to come up with a long-term deficit reduction plan and political bickering brought the country to the brink of default.
Moody's has in the past warned it could cut the United States' rating. On Tuesday it said its view on the U.S. economy and rating had not changed and the upcoming elections offered a chance to remind investors of its thinking.
"This appears to be the shot across the bow," said Dean Junkans, chief investment officer for Wells Fargo Private Bank. "Without some type of rational course to tackle debt reduction, a downgrade is likely."
The heated campaign for president has been underscored by vast differences between Democrats and Republicans about the right mix of tax increases and spending cuts needed to put public finances in order.
The ratings agency said the mix of policies used to reduce the deficit is not as important as agreeing to a credible plan.
"What we are really looking for is the debt trajectory. How you get there in terms of taxes versus spending, we are neutral on that," Steven Hess, Moody's lead sovereign credit analyst on the United States, told Reuters in a telephone interview.
Whether the election will resolve those differences is unclear. Recent polls show Obama has widened his lead over Republican Mitt Romney. Republicans, however, are expected to hold the House of Representatives and possibly win a majority in the Senate, which could reinforce partisan divisions in 2013 budget negotiations.
FISCAL CLIFF LOOMS
While Moody's said it probably won't alter the U.S. rating or outlook until the budget outlook becomes clear, the situation was "highly unlikely" to persist into 2014.
That would only happen, it said, if the method Congress adopted to reduce the deficit involved a large fiscal shock.
"Moody's would then need evidence that the economy could rebound from the shock before it would consider returning to a stable outlook," the agency said.
Such a shock may come if Congress allows a slate of spending cuts and tax hikes take effect as planned in 2013. While this would increase tax revenues and reduce U.S. debt quickly, economists fear it would amount to pushing the economy off a fiscal cliff.
The Congressional Budget Office said it could shrink U.S. gross domestic product by 2.9 percent in the first half of next year, plunge the country into a "significant recession," and cost 2 million jobs.
John Boehner, speaker of the U.S. House of Representatives and a Republican leader in Congress, said Tuesday he was "not confident at all" that divided lawmakers could agree to avoid going over the cliff.
(Editing by James Dalgleish and Andrew Hay)