By Simon Miller
Ratings agency Moody's has placed the UK on a negative watch over fears of contagion from the eurozone.
The ratings agency warned that although the UK was outside the euro area, "the high risk of further shocks (economic, financial, or political) within the currency union are exerting negative pressure on the UK's Aaa rating given the country's trade and financial links with the euro area".
In addition, Moody's warned there was increased uncertainty regarding the pace of fiscal consolidation in the UK due to materially weaker growth prospects over the next few years, with risks skewed to the downside.
As a result, "any further abrupt economic or fiscal deterioration would put into question the government's ability to place the debt burden on a downward trajectory by fiscal year 2015-16".
However, Moody's added that despite concerns over the macroeconomic outlook, the UK's Aaa sovereign rating continued to be well supported by a large, diversified and highly competitive economy, a particularly flexible labour market, and a banking sector that compared favourably to peers in the euro area.
The ratings agency also said the UK economy generally benefited from the significant structural reforms undertaken in the past.
" As a result of these strong structural features, Moody's expects the UK to eventually return to its trend growth rate of around 2.5%, although the return to trend growth is expected to be slower than originally expected, reflecting the nature and depth of the financial crisis," it said.
Moody's added: "The current fiscal consolidation programme remains intact and the government has demonstrated its willingness and ability to take action to address shortfalls. The UK has been proactive in pushing banks to hold more capital and in taking steps to reduce the probability and impact of the sovereign having to use its own balance sheet to support British banks. Further, the outstanding debt stock has important structural features that give the UK government a very high shock-absorption capacity."
Moody's also changed to negative the outlook on the Aaa debt rating of the Bank of England in line with the change of outlook on the UK's sovereign rating.
Speaking on Radio 4's Today programme, Chancellor of the Exchequer George Osborne, commented: "This is a reality check for the whole political system that Britain has to deal with its debts. Here's another organisation, in this case a credit rating agency, warning that if we spend or borrow too much we're going to lose out current rating and that leads to a loss of investor confidence in our economy."
The markets appear to have shrugged off the warning of a possible downgrade within the next 18 months with UK 10-year bonds inching up one percentage point to 2.13%.