14/02/2012 07:30 GMT

Moody's AAA Rating Warning: Why The Influential Agency Has Warned On UK's Credit

Influential credit ratings agency Moody's has warned there is a risk that the UK's economy could lose its gold-plated status. But why has it done this and what does it mean for the UK?

:: What did Moody's say?

The credit ratings agency said the UK still deserves its cherished top-notch rating but its outlook is now negative, which is widely taken as meaning that there is a 30% chance of a downgrade in the next 18 months.

It said the weakened growth prospects for the UK's economy have created increasing uncertainty that the Chancellor will be able to start reducing its debt mountain by 2015/16.

The eurozone debt crisis has also hit confidence and demand for the UK's exports, with the possibility of further shocks to come.

It said: "While the UK currently enjoys 'safe haven' status, there is also a growing risk that the weaker macroeconomic outlook could damage market confidence in the government's fiscal consolidation programme and cause funding costs to rise."

However, this is the mildest form of warning and is not as bad being put on "negative watch", which is taken as meaning there is more chance than not of a downgrade.

Austria and France also saw their triple-A ratings put under threat by being placed on negative outlook.

In addition, Italy, Malta, Portugal, Slovakia, Slovenia and Spain, which did not have top-notch credit ratings, all suffered downgrades.

:: Why does it matter?

Credit ratings are an indication of how safe the agencies believe it is to lend money to a country. If the UK was to suffer a downgrade it could expect the amount it has to pay to borrow money to rise, having fallen to record lows in recent months.

A downgrade would also be a sign that the markets were beginning to lose confidence in the strength of the UK's economy and Chancellor George Osborne's policies.

Vicky Redwood, chief economist at Capital Economics, believes it is "quite possible" that the UK loses its AAA status at some point but even then the UK will "still look the best of a bad bunch" amid the continued problems in the eurozone.

:: Is the view of Moody's shared by the other agencies, Fitch and Standard & Poor's (S&P)?

They have also maintained their top-notch rating for the UK but have issued similar warnings about the dangers facing the economy, stopping short of reducing the formal "outlook".

S&P said in December that the UK could suffer a downgrade as a result of the eurozone debt crisis and said it faced "formidable and rising challenges".

It warned that the government needs to stay on track with its fiscal consolidation if it is to retain its rating and said that any additional weakening in the economic outlook or another bank bailout could derail its efforts.

It put the UK's economy on negative outlook in 2009 but reversed its decision a year later after the coalition government devised its deficit reduction plan.

And Fitch last March warned the legacy of the global financial crisis continued to weigh on the economic and fiscal outlook but said the health cuts and improving banking sector should help ensure it keeps its triple-A rating.

Both agencies have recently downgraded several eurozone countries while S&P took the US down a peg last summer.

:: Will the Moody's warning have a bearing on the Budget next month?

Respected economic think-tank the Institute for Fiscal Studies said earlier this month that Chancellor George Osborne has scope to make temporary tax cuts of £20 billion in his budget to help boost growth.

It suggested that the case for cuts to VAT or employers' National Insurance contributions, as well as increased investment, was "stronger now than a year ago".

But the Chancellor said Moody's announcement highlighted the importance of his austerity measures to get the budget deficit - and the UK's £1 trillion debt mountain - under control.

He has repeatedly said he will not resort to a "plan B" despite claims by Labour and the unions that his austerity measures are choking off the recovery. In addition, the majority of the spending cuts, which are unprecedented in size, are still to come.

A loosening in his austerity measures now looks even less likely, according to Ms Redwood.

She said: "The decision by ratings agency Moody's last night to put the UK on negative outlook is a slight blow for the Chancellor, but nonetheless appears to endorse the government's austerity plans."

However, Moody's judgment will heap yet more pressure on him to announce policies to stimulate the economy after the 0.2% fall in GDP in the final quarter of 2011.

Business leaders have called on the Chancellor to accelerate his credit easing plan to make money available to small businesses to boost growth after the UK's biggest banks failed to hit lending Project Merlin targets agreed with the government.

However, Simon Hayes, an economist at Barclays Capital, said: "The risk is that the economy is not strong enough to bring the deficit down on a timetable that is acceptable to the rating agencies.

"With fiscal policy constrained and monetary policy already extremely loose, there seems little the authorities can do but cross their fingers and hope the demand outlook improves."

:: Is the Moody's statement much of a surprise?

Not really. The economy is currently teetering on the edge of a recession and the Chancellor has already seen targets for reducing the deficit set by the independent watchdog the Office for Budget Responsibility scaled back in recent months in line with forecasts for the UK's economic growth.

London's leading shares index was only slightly down after it opened following the news and the government's borrowing costs on the bond market barely moved.

However, both the euro and the pound took a hit following the announcement.

Hayes said the reasons behind Moody's decision were "unsurprising" and said "a downgrade does not appear imminent".

He added: "In the absence of a sudden flare-up of euro area problems the rating will depend on how growth and the public finances evolve over the coming months and quarters, and Moody's noted that the UK's triple-A rating 'has some resiliency."

:: What else does the Moody's warning tell us?

Out of three scenarios that are most likely to lead to a downgrade, Moody's warned over the threat that renewed problems in the banking sector spill over into the real economy and trigger further bail-outs. This underlines how important it is to fix the banking sector if the UK is to return to stability. It will add weight to the government's radical reforms of the sector, which include forcing banks to ringfence their retail arms from their so-called casino banking investment arms.

:: How are other countries faring?

There were six countries who retained their triple-A rating and were not moved on to negative outlook - Denmark, Finland, Germany, Luxembourg, the Netherlands and Sweden.

These countries are all in northern Europe rather than its weaker southern fringe, and have stronger industry and public finances.

The UK, by contrast, is expected to see its debts peak at 95% of GDP in 2014/15, which is later and at a higher level than in most other AAA-rated countries.

Other countries, such as Ireland, saw no change in its rating or outlook in Moody's latest review but its rating is still several notches behind that of the UK.