The United Kingdom should lose its AAA credit rating and be cut by four notches to A+, according to analysts at Danske Bank in Copenhagen. Having reviewed the UK's fiscal health using the same methodology as that employed by Standard & Poor's, Danske said Thursday, it is now predicting Britain will lose its AAA rating in 2012.
“Without adjusting for 'exceptional factors,' we conclude that the United Kingdom should be given an A+ rating, i.e. four notches below the current rating,” said Danske Chief Analyst John M. Hydeskov in a research note.
“A downgrade of the UK could in our view happen in 2012. We believe it can remain a market theme into 2013. This prediction should however be treated cautiously as our analysis suggests a relatively large political element in the rating process,” he said.
The UK Treasury, however, is confident that its actions on cutting spending will not result in UK debt being downgraded.
“As a result of the UK Government’s fiscal plans, the UK has had its credit rating affirmed by all of the major ratings agencies,” the UK Treasury said in an email to CNBC.
And despite Danske's claims of using S&P's methodology to judge credit ratings, S&P itself affirmed for CNBC that it stands by its current rating and indicated no downgrade is under consideration.
"We have explained very clearly the rationale for our UK rating and we stand by that," the ratings agency said. S&P downgraded the U.S. in early August, jolting markets.
Mark Ostwald, a strategist at Monument Securities, agreed with Danske, however, that the outlook for the UK is weak, though he questioned the extent of the bank's downgrade forecast.
"Four notches is a little extreme—the UK should be on outlook negative as they won't meet their projected targets," Ostwald told CNBC.com on Thursday.
"The UK faces the same risk as everyone else, the financial sector," he said. "The (Bank of England) needs to buy bank bonds, but that would be a very tough sell as it would be seen as another bailout for the banks, not the economy."
Danske laid out five factors it focuses on in order to judge a sovereign credit rating : "1) Institutional effectiveness and political risks, 2) Economic structure and growth prospects, 3) External liquidity and international investment position, 4) Fiscal performance and flexibility, as well as debt burden and 5) Monetary flexibility."
Britain’s coalition government has to a large extent staked its credibility on its management of UK debt since coming into power. The newly created Office for Budget Responsibility is confident about Britain’s debt burden, but Hydeskov disagrees with its main assumptions.
“Real growth could in our view be substantially lower; the GDP deflator could be somewhat lower and the deficit might be harder to reduce than projected. Rather than peaking in 2013-14 and easing slightly towards 69 percent of GDP in 2015-16, we find that the debt burden in our most likely scenario will rise throughout our forecast horizon and reach 84 percent of GDP in five years’ time,” Hydeskov said.
Markets have speculated that the Bank of England could be close to pumping more money into the system via a second round of quantitative easingand Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Company (Pimco), believes UK Chancellor George Osborne should take the foot off the austerity brake in order to support growth.
The yieldon the 10 year Gilt is just 2.26 percent indicating the bond market believes Britain has some of the safest debt in the world.
“The market reaction to a UK downgrade is uncertain with interest rates at depressed levels due to the risk of another global recession . Some investors might attach a higher risk premium to UK assets. The pound can be negatively impacted,” said Hydeskov.