(Updates with Cameron in seventh paragraph.)
Feb. 14 (Bloomberg) -- Chancellor of the Exchequer George Osborne fended off opposition accusations that he’s not doing enough to boost growth and said a warning by Moody’s Investors Service that Britain may lose its Aaa credit rating showed he’s right to focus on reducing borrowing.
“For me it was a reality check,” Osborne told BBC Radio 4’s “Today” show this morning. “It’s yet another reminder that Britain doesn’t have an easy way out of its economic problems.”
The Moody’s warning triggered an attack from the opposition Labour Party, which said the pace of Osborne’s budget cuts is damaging confidence in an economy struggling to avoid a second recession in three years. Osborne says his approach has helped to maintain the top debt rating -- a keystone of government policy --, pushed gilt yields lower and given room for the central bank to loosen monetary policy.
The cuts will see more than 700,000 public-sector jobs axed in the tightest fiscal squeeze since World War II, erasing the bulk of a budget deficit equal to 9 percent of gross domestic product by 2017.
Moody’s said Osborne needs to stick to the plan to maintain confidence. Even then, the U.K. will be vulnerable to shocks that could blow his plans off course given the limited room for a policy response.
The driver behind the change to a “negative outlook” for Britain’s Aaa rated debt is a “weaker macroeconomic environment,” Moody’s said in a statement in London late yesterday. Shocks from the euro area’s sovereign debt crisis are also weighing on the U.K., it said, and the U.K. is now on a par with France and the U.S. as countries with deficits that run a risk of being incompatible with an Aaa rating.
“Why does a credit rating matter? It matters because the most important thing is to keep interest rates low, to keep mortgage rates low,” Prime Minister David Cameron said in remarks shown on Sky News television. “We are doing that by getting to grips with debt and the deficit, but it shows we’ve got to keep doing that and, yes, we’ve got to get growth too.”
Moody’s warning, which carries a one-in-three chance of an outright downgrade, comes less than three months after the debt crisis led Osborne’s fiscal watchdog to cut its growth forecasts and predict the budget deficit through March 2016 will be 112 billion pounds ($176 billion) higher than it previously thought.
“Politicians exchanged blows over what this means for their favored approaches to fiscal austerity, but this decision appears to have little to do with that,” said Philip Rush, a U.K. economist at Nomura in London.
Ed Balls, Labour’s Treasury spokesman, repeated his attack today saying that Osborne’s austerity program is getting in the way of economic expansion and risks tipping the U.K. into another recession.
“I fear the world is making the 1930s mistake, and the ratings agencies are partners in this,” Balls told the BBC. “Today is the first evidence that even the ratings agencies are waking up.”
The pound fell 0.5 percent to $1.5693 at 5:30 p.m. in London, after earlier declining as much as 0.7 percent, the most in a month. U.K. 10-year gilt yields fell 3 basis points to 2.09 percent.
“It is quite possible that the U.K. actually loses its AAA rating at some point,” said Vicky Redwood, chief U.K. economist at Capital Economics Ltd. “Even then, the U.K. will still look the best of a bad bunch. Accordingly, this move should not significantly damage the U.K.’s safe-haven status.”
Spending cuts that helped the U.K. preserve its top credit rating last year and bolstered the pound have been weighing on the currency as investors lose confidence. Sterling had its worst January since 2008 against a basket of nine developed- market peers, falling 0.6 percent, after a 3.1 percent advance in the second half of 2011, according to data compiled by Bloomberg. Gilts are lagging behind lower-rated Treasuries, after world-beating gains of almost 17 percent last year.
“I would support a targeted easing of fiscal policy to keep the economy moving while the consumer pays down debt, Trevor Greetham, director of asset allocation at Fidelity Worldwide Investment in London, said in an e-mailed statement. “Without growth, everything becomes more difficult.”
Investors are beginning to favor policies promoting growth over austerity. President Barack Obama has used outlays to drive America’s recovery even as near-record deficits led to an August downgrade by Standard & Poor’s.
Still, recent rating reductions have done little to deter investors, who poured money into the government bonds of nations such as France and Austria even after the countries lost their AAA ratings at Standard & Poor’s last month.
Moody’s said additional budget cuts announced in November have reduced the scope for further action, making it harder for the government to meet its goal of eliminating the structural deficit by 2017, a cornerstone of Osborne’s policy, if the U.K. is hit by “further abrupt economic or fiscal deterioration.”
The National Institute of Economic and Social Research forecasts the U.K. economy will shrink 0.1 percent this year and grow 2.3 percent in 2013, compared with projections in October for growth of 0.8 percent and 2.6 percent.
Moody’s also said it is less optimistic than Osborne about his plans to start reducing debt after 2015, when it’s due to peak at 95 percent of GDP. The company said debt “will peak later and at a higher level.”
--With assistance from Simon Kennedy and Scott Hamilton in London. Editors: Andrew Atkinson, Eddie Buckle
To contact the reporters on this story: Robert Hutton in London at firstname.lastname@example.org; Gonzalo Vina in London at email@example.com
To contact the editor responsible for this story: James Hertling at firstname.lastname@example.org