31.07.2012

By Simon Miller

Moody's has repeated its warning that the UK is heading for a ratings downgrade if it didn't stick to its austerity measures.

In a briefing note, the rating agency cut its forecast for UK growth after a 0.7% decline in GDP for Q2 last week.

Moody's said that like many countries, the UK was experiencing renewed economic headwinds and warned that should the UK's growth potential have weakened significantly, then this would "create a significant challenge to the government's debt-reduction efforts and would place downward pressure on the country's rating".

Although the rating agency maintained the UK's Aaa rating with a negative outlook, it said there were three scenarios that could lead to a UK downgrade.

The country could see a combination of significantly slower economic growth over a multi-year time horizon - "perhaps due to persistent private-sector deleveraging and very weak growth in Europe" - and reduced political commitment to fiscal consolidation, including discretionary fiscal loosening or a failure to respond to a deteriorating fiscal outlook.

In addition, there could be a sharp rise in debt-refinancing costs, possibly associated with an inflation shock or a deterioration in market confidence over a sustained period; or renewed problems in the banking sector that force a resumption of official support programmes and spill over into the real economy, indirectly causing lower growth and larger budget deficits.

Following the poor Q2 economic data last week, Moody's has cut its 2012 forecast to 0.4% and its 2013 to 1.8% although the agency still expects the UK economy to return to its trend growth of around 2.5%.

“The UK’s Aaa sovereign rating continues to be characterised by a large, diversified and highly competitive economy, a particularly flexible labor market, and a banking sector that compares favorably to peers in the euro area,” Moody’s said.

“The negative outlook in part reflects concerns about the UK’s macro-economic outlook for the next few years.”