The UK has lost its top AAA credit rating for the first time since 1978 on expectations that growth will “remain sluggish over the next few years”.
Moody’s became the first ratings agency to cut the UK from its highest rating, to Aa1.
It said the UK government’s debt reduction programme faced significant “challenges” ahead.
Chancellor George Osborne said the decision was “a stark reminder of the debt problems facing our country”.
“Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it,” he added.
“We will go on delivering the plan that has cut the deficit by a quarter.”
The UK has had a top AAA credit rating since 1978 from both Moody’s and S&P.
Shadow chancellor Ed Balls said the decision was a “humiliating blow to a prime minister and chancellor who said keeping our AAA rating was the test of their economic and political credibility”.
In announcing the ratings cut, Moody’s cited the “challenges that subdued medium-term growth prospects pose to the government’s fiscal consolidation programme, which will now extend well into the next parliament”.
It added that the UK’s huge debts were unlikely to reverse until 2016.
“The main driver underpinning Moody’s decision to downgrade the UK’s government bond rating to AA1 is the increasing clarity that, despite considerable structural economic strengths, the UK’s economic growth will remain sluggish over the next few years due to the anticipated slow growth of the global economy and the drag on the UK economy,” Moody’s said.
But it added that the outlook for the UK is “stable”, meaning it sees no further downgrades in the near future, and added “the UK’s creditworthiness remains extremely high”.
It will massively increase the pressure on George Osborne, from both those who want him to raise taxes and cut spending further and from those who want him to alter course in next month’s Budget and spend more to try to boost growth.
The UK has lost its top AAA credit rating for the first time since 1978 on expectations that growth will remain sluggish over the next few years
The UK’s net sovereign debt was the equivalent of 68% of the country’s annual economic output, or GDP, at the end of last year.
“The very fact that we didn’t see this downgrade happen in the past few years is a testament to the UK’s credibility,” said Lena Komileva, an economist at G+ Economics.
“There are no magic fixes for this kind of problem. It’s not a question of what the government is willing to do, it is what it can do.”
All three major credit agencies last year put the UK on “negative outlook”, meaning they could downgrade its rating if performance deteriorates.
In his Autumn Statement in December, George Osborne acknowledged public finances were taking longer to rectify than planned, and admitted he would be forced to extend austerity measures by at least another year.
Germany and Canada are the only major economies to currently have a top AAA rating – as much of the world has been shaken by the financial crisis of 2008 and its subsequent debt crises.
A downgrade of a credit rating does not necessarily substantially damage the ability to borrow.
The US – the world’s biggest economy – was downgraded from its AAA rating last year, a move that has not materially changed its borrowing costs.
Moody’s removed France’s AAA rating in November.
The UK has experienced a double-dip recession since 2008. It grew in the third quarter of last year – boosted by the impact of the Olympics, but shrunk again by 0.3% in the last three months of 2012.
Earlier this month, the Organization for Economic Co-operation and Development said the Bank of England should be ready to inject more money into the economy to boost growth.
The Bank has so far pumped £375 billion into the financial system, creating money to buy-back government bonds.
The credibility of ratings agencies have also come under attack. S&P is being sued by the US government over ratings it gave to some mortgage-backed assets in the run-up to the global financial crisis in 2007, which subsequently fell dramatically in value.
Moody’s announcement sent the pound falling further in value, but financial analysts said the impact was likely to be limited because the markets had been expecting a downgrade for some time.
Ratings agency Moody’s has lowered its outlook for the European Union’s AAA credit rating to “negative” and warned that the bloc’s rating could be downgraded.
Moody’s said the move reflected the negative outlook for the ratings of the EU’s key budget contributors.
Earlier this year, Moody’s put ratings of Germany, France, Netherlands and the UK on a negative outlook.
It said that these nations were all exposed to the region’s debt crisis, hurting their creditworthiness.
Ratings agency Moody's has lowered its outlook for the European Union's AAA credit rating to "negative" and warned that the bloc's rating could be downgraded
The ratings agency said that in case of “extreme stress”, the AAA-rated member states were more likely to service their own debt obligations rather than “prioritize their commitment to backstop the EU debt obligations”.
It added that if the AAA-rated member states were to default on their debt obligations, there were likely to be defaults on the loans that back the EU’s debt and the bloc’s cash reserve was also likely be stressed.
“Hence, it is reasonable to assume that the EU’s creditworthiness should move in line with the creditworthiness of its strongest key member states,” the agency said.
Germany, France, Netherlands and the UK together account for about 45% of the EU’s budget revenue.
Moody’s warned that if the credit ratings of these member states were downgraded, it could have a knock-on effect on the EU’s rating.
“Additionally, a weakening of the commitment of the member states to the EU and changes to the EU’s fiscal framework that led to less conservative budget management would be credit-negative,” it added.
Moody’s has warned the outlook for Germany’s AAA credit rating is negative, the first step towards a possible downgrade.
Credit ratings agency Moody’s said the country was at risk from the increased likelihood of a Greek exit from the euro and the need to provide more support to Spain.
Concerns are growing that Spain will have to seek a full bailout.
The Netherlands and Luxembourg – both AAA rated economies – were also put on negative watch.
A negative outlook posting from Moody’s, one of a handful of agencies that assess the creditworthiness of borrowers, reflects a higher risk that the actual rating will be cut at some point in the next two years.
France and Austria lost their AAA ratings earlier this year.
Moody’s said there was an increased chance that Greece could leave the eurozone, which “would set off a chain of financial sector shocks”.
It added that policymakers could only contain these shocks at a very high cost.
Representatives from the troika of international lenders are due to arrive in Greece later to assess its progress towards reducing its debts.
They must decide whether Greece is eligible to receive 31.5 billion Euros – the last tranche of a 130 billion euro ($158 billion) aid package agreed in March.
Greece is behind in its plans to cut spending and debt because its economy is shrinking faster than forecast.
Moody's has warned the outlook for Germany's AAA credit rating is negative, the first step towards a possible downgrade
Separately, the German finance minister, Wolfgang Schaeuble, is to meet the Spanish Economy Minister, Luis de Guindos, in Berlin.
The meeting comes a day after Spain’s borrowing costs rose to their highest level since the creation of the euro. Yields on the country’s 10-year bonds remained above 7.5% on Tuesday.
Italy’s 10-year bond yield was also stuck at a high level, with a yield of 6.377%.
Moody’s warned that Germany and other highly-rated countries may have to increase levels of support for countries such as Spain and Italy, who have not asked for a Greek-style bailout but who are struggling with high debt levels.
It said in a statement: “Even if such an event [a Greek exit] is avoided, there is an increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required.
“This burden will likely fall most heavily on more highly rated member states if the euro area is to be preserved in its current form.”
Jim O Neill, the chairman of Goldman Sachs asset management, said the European Central Bank needed to take radical action.
“If Italy gets into already the kind of pressure that we now see on Spain, there would be contagion into the French markets probably… so the policy makers have got to do something a little bit more decisive in terms of monetary interventions,” he said.
Lena Komileva, the chief economist at the investment research company, Gplus Economics, said she too was worried about problems escalating.
“My concern is that an outright sovereign bailout is such a politically unpopular measure that it might just happen too late, which means that Spain will continue to bleed contagion into the rest of the eurozone for the remaining of the year.
“Italy of course is an open target for contagion, but I’m increasingly concerned about the position of France.”
The downgrades come as worries over the eurozone crisis pushed the yields on Spanish and Italian debt to record euro-era highs, reflecting a weakening of faith in the pair’s financial position.
The German Finance Ministry said the country would remain strong, and said that Moody’s was focusing on short-term risks.
“By means of its solid economic and financial policy, Germany will retain its <<safe haven>> status and continue to play its role as the anchor in the euro zone responsibly,” the ministry said.
Rival agencies, including Standard & Poor’s and Fitch, have Germany on the AAA top rating with a stable outlook, implying they do not currently foresee a weakening of its financial position, although all agencies regularly review their rankings.