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UK Deficit Could Surpass Greece: Morgan Stanley

Bad news for U.K. politicians clinging to the notion that the nation’s AAA debt rating indicates a clean bill of financial health. Morgan Stanley expects the British budget shortfall to earn the dubious distinction as Europe’s largest in 2013-14, surpassing even the deficit in troubled Greece.

The investment bank has reduced its U.K. growth forecasts for the coming fiscal year, leading to a deficit of just under eight percent of gross domestic product. “This would leave us with the highest projected European deficit — higher even than Greece, Spain, Ireland and Portugal,” it said in a research note.

Morgan Stanley’s deficit forecast is 25 percent worse than the projection of the U.K. Office for Budget Responsibility, although Morgan Stanley believe the OBR are likely to revise their predictions in December. Any significant reduction represents a risk of a downgrade to the U.K. much-heralded top investment grade.

Britain’s public sector borrowing widened slightly to 14.410 billion pounds ($23.4 billion) last month, the highest for August since records began in 1993. Over the first five months of the fiscal year, borrowing — excluding technical gains related to the transfer of Royal Mail assets to the Treasury — jumped by 22 percent to 59 billion pounds.

The U.K. are currently experiencing a double-dip recession, but the Conservative-led government has continued to champion spending cuts and has resisted changing course.

Mark Littlewood, Director General of the Institute of Economic Affairs — a U.K. think tank — says that the government aren’t delivering the tough cuts promised by George Osborne, U.K. finance minister.

“They implied they were reaching for the chainsaw and in fact just got out the nail clippers,” he told CNBC.com

David Riley, Head of Global Sovereign Ratings at Fitch, told CNBC last month that any deviation from the current austerity plan in the U.K. could affect its triple-A rating. Littlewood says that the theory that the government has talked tough on cuts to appease the debt markets is becoming increasingly popular, although he has a different viewpoint.

“The coalition has somehow got itself into psychologically believing they are acting tough without actually doing so,” he said.

“Or they may have reached the erroneous conclusion that if you tell the electorate that things are going to be truly awful, you somehow earn their undying gratitude when things turn out to merely be slightly grim.”

He added that the government still had the potential however to be the first in our lifetimes to reduce public spending in real terms, albeit very modestly.

Andrew Lilico, Director and Principal at Europe Economics, is not convinced that David Cameron and his government have been particularly vocal about reductions in spending, except in the first year of their term.

“The planned cuts are absolutely enormous, if delivered — but will they be? We now face around a third of the cuts coming in the next Parliament, and that proportion is rising all the time,” he told CNBC.com.

Lilico says George Osborne can't now expect to be able to implement any further material changes to his plans after implementing virtually none of those already announced.

He believes that the country should hope that inertia carries through at least those that have been scheduled.

“If those start not to happen (as I hear disturbing whispers may be the case), we'll be in real trouble,” he said. Lilico sees a real possibility of a British sovereign debt crisis, and expressed amazement that the usually-combative British press has swallowed the government’s assurances of a soft landing.

“Where did anyone get that idea?! It's total nonsense, unsupported by even the most casual glance at history. Did printing our own currency prevent Britain from having a sovereign debt crisis in 1976, for example,” he asked.