Britain's top-notch credit rating may survive the threat of a downgrade because economists still believe in London's resolve to erase a huge budget deficit and the central bank's ability to print money.
Rating agency Moody's imposed a negative outlook on Britain's triple-A rating late on Monday -- the first such warning on London's debt since the euro zone crisis -- saying the country's finances were too weak to cope with another big shock.
The stakes for Prime Minister David Cameron are high. Costly bank bailouts and runaway public spending rises under his predecessor Gordon Brown have saddled Britain with one of the developed world's highest budget deficits.
A downgrade of British debt could spook investors and make it much harder for London to raise the tens of billions of pounds of funding it needs to get through the next few years.
Economists and analysts still believe on balance, however, that Britain will get through the crisis without a downgrade. A Reuters snap poll of 10 economists taken after Moody's announcement gave only a median 27.5 percent chance that Britain would lose its triple-A standing.
Moody's issues a negative outlook if there is a one in three chance of a downgrade.
The warning, however, will hurt the Conservative-led coalition government's economic record and fuel a debate here over whether a different policy mix to bring the economy back on track would yield better results.
While a downgrade would deal a major blow to Chancellor (finance minister) George Osborne, who has vowed to erase the budget deficit within five years, some economists doubt it would significantly drive up borrowing costs.
We do not expect the UK to be downgraded, but believe such an event would still not affect the draw of the gilt market, said Nomura economist Philip Rush.
The fact that Britain had a very strong track record as a debtor, the institutions to raise the money to service its debt and an independent Bank of England should protect the rating. Credibility is everything, Rush said.
The main reason for Moody's move was the crisis in the euro zone, Rush said. If the crisis doesn't intensify, we'd expect the negative outlook to fade away over time even if the growth outlook remains a challenge, he said.
Britain's recovery from the steep slump in 2008/2009 has been weak. Unemployment -- already at a 17-year high -- is set to rise further, and Bank of England Governor Mervyn King has warned the way back to growth would be long and arduous.
But Britain is still enjoying near record-low borrowing costs. The reason is that investors still view its bonds as a relative safe haven in the global debt storm despite a deficit worse than that of France, which saw its AAA-rating downgraded by Standard & Poor's at the end of last year.
Britain, which has already had to give up on balancing the books by the time of the next election in 2015, is aiming for a budget deficit of 8.4 percent of national economic output in the 2011/12 fiscal year, falling to 7.6 percent in 2012/13, still much higher than those forecast for France or the United States.
The risks to those predictions are considerable, in particular if the economy fails to recover this year and next.
Vicky Redwood from Capital Economics predicts 10 billion pounds of extra borrowing in the 2012/2013 fiscal year on top of the government's forecast of 120 billion as she sees the economy contracting by 0.5 percent this year.
A more dramatic shock such as a euro zone break up would send Britain's debt spiraling.
Leading fiscal policy think-tank IFS assumed in its euro break-up risk scenario a drop of Britain's gross domestic product by 2.3 percent in 2012, which would send the government deficit back to nearly 10 percent. However, the IFS still saw the debt-GDP ratio still falling by 2017 even in this case.
The IFS also highlighted a more imminent risk.
Most of the nearly 80 billion pounds in government spending cuts are yet to be delivered. While most of the tax increases are in place now, only 12 percent of the planned cuts to welfare and public services have been carried out so far and successful implementation is not guaranteed.
The impact of the remaining cuts to the services provided is difficult to predict; they are of a scale that has not been delivered in the UK since at least the Second World War, the IFS said in its annual analysis of Britain's public finances.
And while Capital Economics' Redwood sees annual borrowing still at more than twice the government's forecast of 24 billion pounds in 2017, a rating downgrade is not her central scenario.
There are several crucial factors why Britain is seen as safer than most. The average maturity of its debt -- which dictates when the government has to reimburse investors -- is 14 years, much longer than many nations, according to the Britain's Debt Management Office (DMO), giving it more breathing space.
And the central bank has just embarked on another 50 billion pound round of quantitative easing purchases. The Bank of England is still there as the buyer of last resort and it is still buying more gilts than the DMO is issuing, said Monument Securities strategist Marc Ostwald.
Moody's itself noted the Bank of England's key role in safeguarding investors' trust as well as the limited risk of not finding buyers for its debt.
The UK has the lowest refinancing risk of all the large AAA economies, based on the average maturity of the UK's debt stock, ... its large domestic investor base, and the willingness and ability of its central bank to undertake accommodative monetary policy, Moody's said.
Finance minister Osborne, committed to slashing spending by about a fifth across government departments before the next election in 2015, faces the increasingly tough task of pushing through cuts while steering Britain away from a slump.
Treasury sources indicate that the credit rating must be protected at all costs, a sign that Osborne could even pledge further cuts if needed to keep financial markets on side.
The government will stick to its plan to meet its fiscal mandate, one source said.
But sources say there are also senior Treasury officials who worry that the rating is at risk and that the government will struggle to deliver its cuts agenda because of the danger of a prolonged economic stagnation. Officials also worry critics will now be able to label the coalition's economic policy a failure and that voters could respond.
(Editing by Jeremy Gaunt and Michael Stott)