Pound buyers faced losses after the S&P warned that it was cutting its outlook for the pound from "stable" to "negative." The pound lost two percent against the dollar and 1.5 percent against the euro.
"We have revised the outlook on the UK to negative due to our view that, even assuming additional fiscal tightening, the net general government debt burden could approach 100 percent of GDP and remain near that level in the medium term," S&P credit analyst David Beers told CNBC.
S&P did not change U.K.'s sovereign credit rating of "AAA." The UK has had a "AAA" since 1978. Moody's and Fitch both issued statements that they did not see a reason to change the UK's status and reaffirmed their ratings.
What will happen if S&P ends up lowering the U.K.'s rating? It would prompt heavy and automatic selling by official reserve managers. "If there's an actual downgrade, that's an economic event that has significant implications for flows," Bilal Hafeez of Deutsche Bank in London told the Wall Street Journal.
Official data released shortly after the S&P announcement showed British public borrowing hit a record high in April, which was the first month of Britain's new tax year. The recession-hit economy has battered public finances. Britain expects to issue a record £220 billion of gilt this year. Britain had little trouble selling £5 billion of gilt on Thursday, which calmed the markets after the downgrade.
One of the big questions weighing on S&P's decision is the result of the upcoming elections and how that will impact governmental fiscal and monetary decisions. "The rating could be lowered if we conclude that, following the election, the next government's fiscal consolidation plans are unlikely to put the UK debt burden on a secure downward trajectory over the medium term. Conversely the outlook could be revised back to stable if comprehensive measures are implemented to place the public finances on a sustainable footing, or if fiscal outturns are more benign than we currently anticipate," Beers said abut S&P's decision.
Prime Minister Gordon Brown seems to be facing defeat in a general election that must be called some time in the next 12 months. It's this political uncertainty that made S&P issue its downgrade warning. Was it trying to send a message to British politicians?
Lita Epstein has written more than 25 books, including the Complete Idiot's Guide to Foreign Currency Trading.