Markets plunge as US rating reduced

World markets plunged today after a key ratings agency shocked traders with a downgrade to its outlook for US government debt.

Standard & Poor's cut its outlook for sovereign debt in America to negative from stable due to risks from the country's growing deficit.

S&P warned that while the US has a high-income, diversified and flexible economy, the country's ballooning deficit could offset these positives over the next two years.

The move, a serious blow to President Barack Obama's administration, sparked declines on London's FTSE 100 Index, which dropped more than 2%, as well as Wall Street's Dow Jones Industrial Average, which fell nearly 2%.

S&P is one of three main credit rating agencies which offer an informed opinion on the credit-worthiness of a company or government. Moody's and Fitch are its main competitors.

S&P reaffirmed its current AAA rating for US government debt, but warned there was a one in three chance of a downgrade in the next two years.

The agency said the US deficit grew to 11% of gross domestic income in 2009 - much higher than the average of 2% to 5% in the previous six years.

In its note, S&P said: "We believe there is a material risk that US policymakers might not reach an agreement on how to address medium and long-term budgetary challenges by 2013."

Richard Hunter, head of UK equities at Hargreaves Lansdown Stockbrokers, said the announcement had taken the markets by surprise.

He said: "It also comes as a timely reminder that although focus has tended of late to centre on peripheral Europe, opposing political forces in the US need to unite and tackle an increasingly difficult deficit situation."

The US dollar dropped after S&P's slashed the outlook, falling against the euro and yen, but has since stabilised.

Kathleen Brooks, research director at Forex, said the downgrade was a "shocker".

She said: "The US may be in the last throes of being a safe haven, and the notion of the Treasury being a risk-free asset may die a slow death from here.

"It could signal a shift towards scrutiny of the US's public finances away from Europe, which has been the centre of attention for most of this year."

The move sparked a rally in gold, seen as a secure investment, which hit a new high as it moved close to 1,500 US dollars (£927) an ounce.

Banks and mining stocks on the FTSE 100 Index suffered significant declines.

Barclays fell more than 4% while Royal Bank of Scotland dropped nearly 3%.