S&P backs UK's AAA rating as Government wields the axe

Agency predicts slower growth but warns against abandoning austerity measures

The coalition's austerity drive means that the UK still commands a top-notch AAA credit rating despite facing slower growth, Standard & Poor's (S&P) said yesterday.

The agency, which in August stripped the US of its AAA rating for the first time, reaffirmed its positive view of the UK's creditworthiness just as the Chancellor, George Osborne, took to the podium to deliver his speech at the Conservative party conference in Manchester.

Endorsing Mr Osborne's cost cutting measures, S&P said the country's AAA rating could come under pressure if the Government's commitment to scaling back the deficit faltered in the face of weakening growth.

For now, however, its analysts expect that the "political consensus on fiscal policy will broadly hold for the near future, and that the Government will implement the measures in its ... fiscal consolidation program in order to achieve it targeted savings".

But while the Coalition wields the axe, growth will remain modest, with the agency predicting that the economy will expand by "around 1.8 per cent on average in 2011-2014, lower than the 2.5 per cent forecast by the Office for Budget Responsibility".

"Although the economy has exited recession, recovery has been lacklustre, with output essentially stagnating since the fourth quarter of 2010," S&P said. "In our view, the UK Government's efforts over the next few years to engineer a steep correction in the fiscal accounts will likely weigh on the economy."

This was "especially pertinent" in the short term, it added, as households strove to cut their debt burdens and banks tightened lending. The agency also questioned the Government's claim that the private sector would make up for cuts in the public sector.

"The reliance of UK economic growth in recent years on a limited number of sectors and regions, fuelled by rising private and public-sector debt, is an issue that the governing coalition intends to address," it said.

"In our view, however, the official assumption that the private sector will quickly step in to replace the withdrawal of public spending may prove optimistic, especially given weakening external demand and underlying structural impediments to economic growth, which will likely take time to correct."

And, as growth faltered, the Coalition was likely to find itself with a bigger-than-expected deficit, the agency warned, forecasting "a general government deficit of around 3.3 per cent of GDP" in the 2014 calender year, against the Government's 2.6 per cent projection for the 2014-15 fiscal year.

The assessment came as the Institute of Fiscal Studies said slower growth was likely to mean an extension of the fiscal squeeze beyond the next election, which is expected in 2015. "My guess is that the next set of growth forecasts will say the job won't be done and there'll be a couple of years of squeeze going into the next Parliament," the think-tank's director, Paul Johnson, said. "It will most likely be that we'll get that balance later than they were hoping a year ago... They will still actually have to be tightening."