Britain suffered its first ever sovereign ratings downgrade from a major agency on Friday, after Moody's stripped the country of its coveted top-notch triple-A rating, dealing a major blow to finance minister George Osborne.
Moody's cut Britain's rating by one notch to Aa1 from Aaa, with a stable outlook, blaming weak prospects for Britain's economy over the coming years which have thrown the government's deficit reduction strategy off course.
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Austerity has been the watch word for Osborne's fiscal policy since his Conservative-led coalition came to power in 2010 after an election in which he vowed to defend Britain's triple-A rating, which keeps down borrowing costs.
But weak growth - which the opposition Labour Party blames partly on too much austerity - has pushed the government's goal of largely eliminating the budget deficit by 2015 at least two years off track.
Many in financial markets had expected at least one major agency to downgrade Britain this year.
Following the release of January public finances data on Thursday, the government's fiscal watchdog said the government may struggle to reduce borrowing at all during the current fiscal year, which finishes at the end of March.
Britain now joins the United States and France in having lost its triple-A rating from at least one major agency, having held the top-notch rating from Moody's and S&P since 1978, and from Fitch Ratings since 1994.
Moody's said that despite considerable structural economic strengths, Britain's growth is expected to be sluggish due to a combination of weaker global economic activity and a drag "from the ongoing domestic public and private-sector de-leveraging process."
Trend growth for Britain's economy is between 2 and 2.5 percent, Moody's sovereign credit analyst Sarah Carlson said in a telephone interview with Reuters.
"We see growth slowly building back up to that trend ... but if you take a combination of the growth and fiscal dynamics, the result is that the debt burden of gross general debt to GDP peaks in 2016, which is substantially later than was expected a few years ago," she said.
Osborne insisted in a statement that now was not the time to change course and borrow more to boost growth, which the Labour Party as well as some political allies have recommended.
"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. "Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it."
Sterling fell to around $1.5160 after the downgrade from about $1.5240, just off Thursday's fresh 2-1/2-year low.
"It's a pretty big deal. We didn't see a huge reaction in the pound because it's late in the New York session. But you'll see some more aggressive selling when the markets open (in Asia) on Sunday," said Kathy Lien, managing director at BK Asset Management in New York.
But Charles Diebel, a fixed income strategist at British bank Lloyds, was more sanguine about the impact of the downgrade on British government debt prices.
"This has been speculated as inevitable and is most likely largely in the market. I would expect only very limited damage to the gilt curve and to sterling. Historically, losing your AAA is actually a bond bullish event," he said.