Pound under new attack as agency says it will cut UK's credit rating

The pound's value against the dollar tumbled yesterday when a leading credit ratings agency suggested that Britain might lose its cherished AAA status because it was the "potentially most at risk" of the major economies.

Fitch Ratings said the UK's sovereign credit rating was most at risk among the advanced economies because the country required "the largest budget adjustment". David Riley, the head of sovereign ratings at Fitch, added: "Our stable rating outlook reflected our expectation that the UK Government will articulate a stronger fiscal consolidation programme next year."

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Following the announcement, sterling, which had been enjoying a positive run against an enfeebled dollar, fell by about a cent from a three-month high to $1.66. However, it rallied later after Gordon Brown reiterated the Government's commitment to repairing the public finances. The Prime Minister said: "We have assured people that, as a result of our deficit-reduction plan that we announced in our Budget in April, we are taking the necessary action to cut our deficit by half... probably ahead of other countries.

"I think the ratings agencies will take into account that these are world issues that have got to be dealt with, not just by one country, but many countries."

The pound also fell back against the euro, to €1.11.

"Many credit profiles of major AAA sovereigns have been significantly weakened by the financial crisis and the subsequent recession," Mr Riley added. "The already outsized budget deficits and the rise in government debt has reduced the 'fiscal space' for policymakers to respond to further adverse shocks."

In May, Fitch's rival Standard & Poor's decided to change its outlook for the UK economy from "stable" to "negative". S&P indicated then that it would wait to see what concrete steps were taken to bring down the deficit next year before reviewing the rating again.

Fitch's concerns, as with S&P and other global bodies – from the International Monetary Fund to the European Commission – centre on Britain's soaring budget deficit, which is set to approach £200bn this fiscal year, or about 13 per cent of GDP. The pre-Budget report, expected within a month, will offer the Chancellor, Alistair Darling, a showcase for any new plan to return to fiscal sustainability.

John Cridland, deputy leader of the Confederation of British Industry, said: "The UK's credit rating must be put beyond doubt and the budget returned to balance by 2015. We have called for any new administration to set out within 100 days of taking office a clear and credible path to achieve this aim.

"The emphasis must be on spending cuts and re-engineering public services rather than tax increases. Vague promises of efficiency savings will not be enough. However, capital spending must be protected."

Apart from the political embarrassment involved in any threat to the credit rating, such a move would have severe consequences for the cost of servicing the UK's debt, because investors would demand higher interest as a "risk premium" against the possibility of default. Inflation, rather than outright default, has been the traditional British method of defraying its debt burden.

The cost of hedging against losses on UK government bonds through credit-default swaps widened to 55 basis points, the most since 8 September, according to data compiled by Bloomberg. America's credit rating also might be at risk if its fiscal position did not stabilise within the next couple of years, Fitch added.

Around the world: The good, the bad and the ugly

* Standard and Poor's says only 17 nations or territories deserve AAA status. The elite are mostly larger, advanced economies, but there are exceptions. S&P's AAA list comprises Australia, Austria, Canada, Denmark, Finland, France, Germany, Guernsey, the Isle of Man, Liechtenstein, Luxembourg, the Netherlands, Norway, Singapore, Sweden, the UK and the US.

* Britain is the only AAA-rated nation that also has a negative outlook because its national debt is set to rise to 100 per cent of GDP, according to S&P.

* If the UK were downgraded, it would find itself with plenty of company. Ireland lost its AAA rating in March, as did Spain in January. Japan ceded top status in 2001, as did New Zealand in 1983. Canada has clambered back from a downgrade to AA+ in 1992. Others temporarily downgraded include Denmark (from 1983-2001), Finland ( 1992-2002) and Sweden (lost its AAA rating in 1993 but regained it in 2004).

* Less newsworthy than the UK, Kenya's B rating was reaffirmed by S&P yesterday, meaning that "the financial situation varies noticeably", and where political worries also remain.

* Ecuador and the Seychelles are graded SD, indicating that they have "selectively defaulted".

* At the start of 2008, there were about 20 nations and only 12 corporations that had a AAA rating. But more than 64,000 structured financial products, such as mortgage-backed securities enjoyed AAA status, though many became nearly worthless. This led to much criticism of the ratings agencies.