U.K. May Lose AAA Rating at S&P as Finances Weaken

By Lukanyo Mnyanda

May 21 (Bloomberg) -- Britain may lose its AAA credit rating for the first time as government finances deteriorate in the worst recession since World War II.

Standard & Poor’s lowered its outlook on Britain to “negative” from “stable” and said the nation faces a one in three chance of a ratings cut as debt approaches 100 percent of gross domestic product. The pound fell the most in four weeks against the dollar, the FTSE 100 Index slid as much as 2.8 percent and the cost of insuring U.K. debt against default rose.

Britain needs to sell a record 220 billion pounds ($344 billion) of bonds in the fiscal year through March 2010 as the economy contracts and Chancellor of the Exchequer Alistair Darling predicts that the budget deficit will reach 175 billion pounds, or 12.4 percent of GDP. The U.K.’s worsening finances parallel the public perception of Prime Minister Gordon Brown, whose Labour government has trailed the Conservative opposition for more than a year in polls.

“The downgrade highlights the precarious fiscal outlook the U.K. economy faces,” said Nick Stamenkovic, a strategist in Edinburgh at RIA Capital Markets, a securities broker for banks and institutional investors. “The huge amount of issuance to face the gilt market in the coming months will push yields to the upside. We’re bearish.”

Gilts Drop

Gilts fell, pushing the yield on the 4.5 percent note due March 2019 up as much as 13 basis points to 3.71 percent, before rebounding to 3.62 percent at 12:14 p.m. in London. The budget deficit increased to 8.5 billion pounds last month, the most for April since records began in 1993, the Office for National Statistics said in London today.

Britain would become the fifth western European Union nation to lose its rating because of the economic slump, following Ireland, Greece, Portugal and Spain. The U.K.’s debt load next year will be 66.9 percent of GDP, exceeding Canada’s 29.1 percent and Germany’s 58.1 percent, according to April 22 forecasts by the International Monetary Fund. The U.S. will be at 70.4 percent, and the 16-nation euro area at 69 percent, according to the IMF.

“The key from a market perspective is whether this is a stand-alone U.K. problem or whether it is the start of a trend where the agencies start to review the ratings of various sovereigns across the developed world,” said Gary Jenkins, head of credit research at Evolution Securities Ltd. in London. “If this is really just a case of the U.K. deteriorating as a credit then it could have a significant impact going forward.”

Unemployment Jumps

Brown’s efforts to patch up the nation’s finances are being hobbled by an economy mired in its first recession since 1991. Unemployment surged to 2.2 million in March, the highest since 1996, and tax income has dropped 10 percent in the past year. The IMF expects gross domestic product to contract 4.1 percent this year, the most since World War II.

British Land Co., the largest office developer in London, reported a record annual loss of 3.9 billion pounds today as property values slumped across the nation’s capital.

There are no U.K. companies with AAA ratings by S&P or Moody’s Investors Service. British Land is rated BBB by Fitch Ratings, its second-lowest investment-grade ranking.

The difference in yield, or spread, between U.K. 10-year bonds and equivalent German securities widened six basis points to 21 basis points following the S&P statement. As recently as March 19, gilts yielded less than bunds.

Stocks, Pound Slide

The FTSE index declined the most since March 30. The pound dropped 0.7 percent to $1.5639 and weakened 0.7 percent against the euro to 88.07 pence. Credit-default swaps on U.K. debt rose 5.5 basis points to 78, according to CMA DataVision prices.

European governments are increasing borrowing to bolster ailing economies and bail out banks reeling amid the fallout from the global credit crisis. Ireland had its AAA credit rating removed by S&P on March 30. S&P lowered the ratings of Spain, Portugal and Greece in January.

“We have revised the outlook on the U.K. to negative due to our view that, even assuming additional fiscal tightening, the net general government debt burden could approach 100 percent of gross domestic product and remain near that level in the medium term,” S&P analysts led by David Beers in London, said in the report today.

The British economy, the second largest in Europe, shrank 1.9 percent in the first quarter, the biggest contraction since 1979, when Margaret Thatcher became Prime Minister, the Office for National Statistics said on April 24. Darling said in his budget the economy will slump about 3.5 percent this year, before expanding in 2010.

Government Support Slumps

Brown needs to increase borrowing to pay for rescuing banks that have reported $121 billion in credit-related losses and writedowns since the start of 2007. The government pledged 40 billion pounds to bail out lenders and hundreds of billions of pounds in loan guarantees.

Labour trailed the Conservatives by as much as 22 points this month, according to a BPIX Ltd. survey completed on May 16. Conservatives had the support of 42 percent of voters, compared with 20 percent for Labour, according to the poll, which didn’t provide a margin of error.

Support for Brown is tumbling in the run-up to European elections on June 4 as a scandal about lawmakers’ expenses engulfs British politicians. House of Commons Speaker Michael Martin resigned two days ago, the first time that has happened since 1695.

Bank of England

The government gave the Bank of England authority to purchase as much as 150 billion pounds of assets with newly printed money in an attempt to lower borrowing costs.

Britain’s “balance sheet is deteriorating rapidly,” Moody’s analysts led by Arnaud Mares in London wrote in a report on April 23. “The government is taking risks with public finances.”

Some reports indicated the economic decline is slowing. Nationwide Building Society said April 30 house prices fell less than forecast in the month, after posting a surprise increase in March. Consumer confidence climbed to the highest level in a year during April, GfK NOP said in a report the same day.

To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net