Paris-based credit rating agency Fitch warned the government of the United Kingdom Thursday that the country still stood to lose its sterling AAA rating were the economic situation in Europe to deteriorate further. The action came at a politically sensitive time for Britain.

Citing high levels of government debt and very limited fiscal space to absorb further adverse economic shocks following recent austerity measures, the rating agency said it was placing a Negative outlook watch on the nation's sovereign debt rating. That move is taken to mean there is a more than one-in-two change the rating will be downgraded in the near future.

In light of the considerable uncertainty around the economic and fiscal outlook, including the risks posed to economic recovery by ongoing financial tensions in the Eurozone and against the backdrop of a still large structural budget deficit and high and rising government debt, the negative outlook indicates a slightly greater than 50 percent chance of a downgrade over a two-year horizon, Fitch analysts wrote in a report.

Politically-Contentious Time In U.K.

The announcement from Fitch comes at a politically-contentious time. British Chancellor of the Exchequer George Orsborne is set to announce the government's budget next week, and is facing pressure from politicians across the spectrum, including some in his own Conservative Party, to include some kind of discretionary stimulus in the plan.

Osborne has steadfastly rejected those calls, even as the current austerity measures have put the country on the edge of a recession, as the Fitch report stated.

A spokesman for the English Treasury told the Dow Jones Newswires, however, that the Fitch report should be taken as further proof stimulus measures would be counter-productive, as that would entail discretionary fiscal easing that results in government debt peaking later and higher than currently forecast.

This is a just another warning to anyone who believes there can be deficit financed giveaways in next week's budget, the spokesman told the newswire.

Investors in British securities were not happy on the news. In late afternoon trading in London, the benchmark FTSE 100 Index was down 0.35 percent, underperforming European equity markets elsewhere. Benchmark ten-year gilts fared even worse, going up 16.7 basis points in yield. The British pound, which had been bouncing against a technical floor at $1.57, weakened against the dollar, to $1.5683.

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