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Moody's threat to strip U.S. of top rating

Fiscal cliff danger: Another downgrade?

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Story highlights

  • Moody's says it will cut America's credit rating if Congress fails to reach a debt deal
  • Ratings agency gave the country a deadline of 2013 to reach deficit reduction deal
  • Rival ratings agency S&P stripped the U.S. of its top rating last year
  • Dollar fell after the statement but reaction in stock, credit markets limited

Moody's has threatened to downgrade America's prized triple A credit rating if Congress fails to reach a deficit reduction deal, raising the stakes in the fiscal debate that lies at the heart of the November election.

The rating agency said on Tuesday it is considering joining its rival Standard & Poor's, which stripped the US of its top rating last year, if a deal is not reached by the end of 2013. The threat is likely to feed into election campaign concerns over the state of the economy and lift Republican hopes of a boost for Barack Obama's challenger, Mitt Romney, by focusing attention on the size of the national debt.

It also adds pressure on lawmakers in Congress to lay the groundwork for critical negotiations on fiscal policy that will begin almost immediately after the election on November 6.

The comments made clear that a deal to avert the so-called "fiscal cliff" -- a series of tax increases and automatic spending cuts due in early January -- may not be enough to prevent a downgrade, and that a broader agreement to shrink America's debt pile over the medium term would need to be crafted.

Budget negotiations next year "will likely determine the direction of the US government's Aaa rating", Moody's said, adding that it may cut the country's rating to Aa1 if the results were not satisfactory. "What we're looking for is a downward trajectory of the debt over the medium term," said Steven Hess, lead analyst for the US sovereign rating at Moody's in New York.

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A Moody's downgrade, on top of S&P's controversial move in August 2011, would further taint the standing of US Treasury securities as the world's purest risk-free asset.

The dollar fell broadly after the warning, while the euro touched a four-month high. Reaction in the stock and credit markets was limited, but analysts said a deterioration in the country's finances and a potential ratings downgrade could weigh on bond prices.

Moody's comments came as Congress was closing in on a deal to fund the government for six months, averting a federal shutdown until at least March 1 and allowing lawmakers to return to their districts for campaigning.

But the temporary truce on discretionary spending levels belies the fact that little if any progress has been made by Congress in solving the mix of automatic spending cuts and tax increases that could tip the economy into recession if no action is taken by the end of the year.

John Boehner, the Republican House speaker, said he was "not confident at all" that Congress would be able to reach an agreement to avoid the fiscal cliff, which would set the stage for a broader deficit reduction deal, blaming Democrats and Mr Obama for the impasse.

"The House has done its job on both the sequester and on the looming tax hike that will cost our economy 700,000 jobs. The Senate at some point has to act. And on both of these, where's the president, where's the leadership?" Mr Boehner said on Tuesday.

Both campaigns were observing a temporary ceasefire to mark the 11th anniversary of the 9/11 attacks. In the wake of the Democratic convention Mr Obama has opened up a small lead in the polls but his challenger's campaign is expected to seize on the downgrade warning to intensify their assault on his spending record.

Negotiations on the fiscal cliff are only expected to start in earnest once the new balance of power in Washington is determined by the election. At around the same time it will also be necessary to raise again the limit on federal government borrowing.

But the Moody's warning underscored that a deal will have to be accompanied, or followed shortly after, by a broader agreement to reduce medium-term debt levels, involving greater tax revenues, cuts to entitlement programmes or both, if investors are to accept it as credible.

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