Moody's says euro crisis endangers UK's top-notch rating

A Moody's sign on the 7 World Trade Center tower is photographed in New York August 2, 2011.

LONDON (Reuters) - Britain's top-notch debt rating is under threat from the crisis in the euro zone, and further shocks to the country's economy could derail government efforts to balance the budget, ratings agency Moody's said on Tuesday.

Britain's scope to absorb further fiscal shocks while retaining its stable outlook and triple-A rating have deteriorated over the past year due to weak growth, and the country faces "formidable and rising challenges," Moody's said.

"Since the last annual report, the amount of headroom for Britain has declined," Moody's analyst Sarah Carlson told Reuters after the publication of the ratings agency's end-of-year assessment of Britain's ability to repay its debts.

Markets are on the lookout for news on France's AAA-rating, which led to a spat between Paris and London after French officials suggested Britain rather than France should be next in line for a ratings downgrade.

Britain is still enjoying markets' trust, and yields on its 10-year bonds are near record-lows, just above 2 percent.

"The currently stable outlook on the UK government's Aaa rating depends in part on the assumption that the government will stay on track with its fiscal consolidation programme," Moody's said in its annual credit report.

Moody's stressed that its report was an annual update to markets and did not constitute a rating action.

"Any additional weakening in the macroeconomic outlook or a need to support the banking system could temporarily set back the government's fiscal consolidation efforts," it added.

"As a result, the outlook on the rating is likely to be sensitive to future developments in the euro area's debt crisis, even though the UK is not a member of the monetary union," it said.

Last month Chancellor George Osborne had to propose further austerity measures stretching beyond his original 2015 target, as weak growth is hitting his efforts to erase the country's budget deficit of nearly 10 percent.

A Treasury spokesman said the government's deficit reduction plan has helped restore confidence in the UK economy.

"However, as Moody's report points out, the UK is not immune to the problems facing our trading partners in the euro area; the crisis is having a chilling effect across Europe and it is important that the euro area continues to take decisive action to fix their problems," the spokesman said.

Britain has long been urging European leaders to fix the debt crisis in the euro zone, though the government has made clear that it will not contribute any money to a solution.

Relations between Britain and its European Union partners, particularly France, soured when Prime Minister David Cameron refused to sign a European deal designed to help solve the debt crisis after failing to win safeguards for the City of London.

Moody's noted that Britain was one of the most competitive large advanced economies in the world and had a track record of reversing increases in debt over many decades.

"Its national currency and central bank provide the UK with substantial flexibility in developing responses to economic and financial shocks," Moody's said.

Debt refinancing risks are limited for the UK due to the long average maturity of around 14 years for its debt, its large domestic investor base, and the willingness and ability of its central bank to purchase government debt.

(Additional reporting by Fiona Shaikh and David Milliken)