NEW YORK/LONDON (Reuters) - Fitch Ratings revised down its outlook on Britain's AAA rating to negative on Wednesday, warning the nation faced a greater than 1-in-2 chance of losing its top-notch status in the next couple of years if the government eases back on its debt-cutting measures.
The Fitch action, which comes just a week before British finance minister George Osborne presents his annual budget to parliament and follows a similar move by Moody's just a month ago, is likely to dampen calls for the government to soften its stance on austerity.
Fitch affirmed Britain's triple-A status but said that a downgrade could be triggered by "discretionary fiscal easing that resulted in government debt peaking later and higher than currently forecast."
"This is a salutary reminder as to why Britain needs to deal with the enormous debts and deficit that we inherited, why we have got to stick to those plans," said British Treasury minister Danny Alexander.
"And it should be a wake-up call to anyone who thinks we can afford as a country to loosen the purse strings. We can't afford to do that, and that is why there will be no unfunded giveaways in next week's budget."
Britain's Conservative-led coalition government has staked its reputation on plans to virtually eliminate a budget deficit that was at a record 11 percent of gross domestic product when it came to power two years ago.
However, progress has been slow due to a faltering domestic economy and weak demand in the euro zone, Britain's biggest trading partner, forcing the government to admit that it will take two years longer than planned to meet its deficit goal.
Osborne has insisted there will be no unfunded giveaways in the March 21 budget, but he has been coming under growing pressure from members of his own Conservative party, as well as from the Liberal Democrat coalition partner, to find ways to boost demand and kick-start Britain's lacklustre economic recovery.
The measures being demanded by fellow lawmakers include raising the threshold at which income tax is paid to alleviate the squeeze on middle-income families, and cutting corporation tax to encourage firms to invest and create jobs.
"Fitch's move heaps further pressure on the Chancellor (Osborne) to stick to his fiscal austerity plans," said Howard Archer, economist at IHS Global Insight.
Britain's Office for Budget Responsibility forecasts that public sector net debt will peak at 78 percent of GDP by 2014/15 but fall thereafter, and Fitch said that although this was in line with its own forecast for Britain, it was at the limit of the level consistent with a triple-A rating.
The agency said that although risks to the UK from the euro zone debt crisis had diminished, the situation had not been completely resolved and could yet blow up again, endangering Britain's ability to stick to its debt reduction plans.
"The revision of the rating outlook to negative reflects the very limited fiscal space to absorb further adverse economic shocks in light of such elevated debt levels," Fitch said in a statement.
Britain's recovery from a deep slump in the aftermath of the 2007/08 financial crisis has been fitful. The economy shrank at the end of last year, raising concerns about a double-dip recession and prompting the Bank of England to restart its quantitative easing bond-buying programme.
And although recent surveys have indicated Britain may avoid another recession, unemployment is still at a 16-year high.
Fitch noted that the Bank's stimulus and the credibility of the government's fiscal consolidation plans had helped to drive down the cost of borrowing. Moreover, the average maturity of Britain's debt, which at 14 years is twice that of some of its peers, also helps to underpin Britain's triple-A rating.
Economists reckon Britain stands a good chance of keeping its prized triple-A status thanks to modest recovery from the second half of this year and the government's debt-reduction plans.
"But there are undeniably appreciable risks to this outlook, some of which are outside the UK's control," cautioned IHS Global Insight's Archer.