George Osborne embarrassed as UK's credit rating drops

George Osborne was dealt a severe political blow tonight as the UK was stripped of its top notch rating by the credit agency Moody’s.

Britain was downgraded by one notch from AAA to Aa1 by the agency, which first put the UK’s sovereign rating on negative watch one year ago.

Moody’s said that the move was prompted by “continued weakness in the UK’s medium-term growth outlook” and the country’s “high and rising debt burden”. The UK economy contracted by 0.3 per cent in the final three months of 2012 after suffering a post-Olympics comedown. The economy has grown by just 1 per cent since the Chancellor took office in June 2010.

Last December the Chancellor was forced to abandon his plan to reduce the national debt as a share of GDP by the end of the Parliament thanks to weak tax revenues which slowed his deficit reduction timetable. This week the Government’s official watchdog, the Office for Budget Responsibility warned that without an unlikely surge of revenues in the final two months of the financial year the deficit for 2012/13 would be higher than the previous year.

The downgrade came after the UK financial markets had closed, but is unlikely to come as a shock to investors as such a move had been widely expected for months. The economic impact is also likely to be limited. The US and France have seen their borrowing costs decline since they lost their own AAA ratings. The downgrade, however, is a serious political embarrassment for Mr Osborne who said upon taking office that retaining the UK’s AAA rating was an economic “benchmark” against which he wished to be judged by the British public.

The Chancellor insisted tonight that the downgrade would not prompt him to adopt an economic Plan B as many critics have been urging.

“Tonight we have a stark reminder of the debt problems facing our country - and the clearest possible warning to anyone who thinks we can run away from dealing with those problems” he said in a statement. “Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it”.

The chief economist of the International Monetary Fund, Olivier Blanchard, has urged Mr Osborne to slow the pace of his planned spending cuts this year in order to support growth – a plan also urged by the Labour opposition and a growing number of independent economists.

Two of the other major global credit agencies – Standard & Poor’s and Fitch – also have Britain on “negative outlook” and could follow Moody’s in downgrading the country’s sovereign debt after next month’s Budget.