The United States lost its top-tier AAA credit rating from Standard & Poor's on Friday, hours after investors alarmed by the euro zone debt crisis forced Italy to speed up an austerity drive.
In a sign of how concerned world leaders are about a slide in stocks that wiped about $2.5 trillion off global markets this week, Italian Prime Minister Silvio Berlusconi said finance ministers from the Group of Seven industrialized nations would meet in just a few days to seek a common plan of action.
Worries the euro zone debt crisis was spreading and the United States was slipping into recession have driven the rout in financial markets. Better-than-expected jobs growth in July helped support Wall Street on Friday but stocks slipped back into the red in late trading.
The S&P cut in the U.S. long-term credit rating by one notch to AA-plus was an unprecedented blow and resulted from concerns about the nation's budget deficits and climbing debt burden. The move is likely to eventually raise borrowing costs for the American government, companies and consumers.
As well as cutting the rating, S&P said the outlook was negative, a sign that another downgrade is possible in the next 12 to 18 months.
S&P said political gridlock in Washington was part of the reason behind the cut, saying politics was preventing the United States from addressing its deficit and debt problems.
The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics, S&P said in a statement.
While the impact of the rating cut on financial markets when they reopen on Monday may be modest because the decision was expected, the shift may have a major long-term impact for the U.S. standing in the world, the dollar's status, and the global financial system.
The global system must now adjust to the many implications and uncertainties of the once-unthinkable loss of America's AAA, Mohamed El-Erian, co-chief investment officer at Pacific Investment Management Co., which oversees $1.2 trillion in assets, told Reuters.
In Europe, Italy buckled to world pressure by pledging to bring forward cuts to balance the budget in 2013 in return for European Central Bank help with funding.
After a frantic round of telephone diplomacy, Berlusconi said his government would bring forward cuts to balance the Italian budget in 2013, a year ahead of schedule, and rush through welfare and labor market reforms.
We consider it appropriate to introduce an acceleration of the measures which we introduced recently in the fiscal planning law to give us the possibility of reaching our objective of balancing the budget early, by 2013 instead of 2014, Berlusconi told a news conference after a day of calls with world leaders including German Chancellor Angela Merkel and Treasury Secretary Tim Geithner.
Sources close to the matter told Reuters the ECB had demanded such measures in exchange for buying bonds to ease the pressure on Italy, which has come under market attack.
Berlusconi said the G7 finance ministers meeting could also prepare the ground for a meeting of heads of state.
Late in the day, the White House said President Barack Obama had spoken separately with Merkel and French President Nicolas Sarkozy about the eurozone crisis but offered no details.
The ECB had no immediate reaction to Italy's announcement but a European Commission spokesman said the measures responded to assessments set out earlier in the day by EU Economic and Monetary Affairs Commissioner Olli Rehn and go in the right direction.
Investors have been unimpressed by a 48 billion euro austerity package passed by Berlusconi's government, partly because most of the measures were delayed until after elections scheduled for 2013, for clear political reasons.
The crisis was receiving attention at the highest levels as leaders of Germany, France and Spain conferred by telephone during the day.
Discord among EU policymakers over how to stop a disastrous spread of the sovereign debt crisis to Italy and Spain, the euro zone's third and fourth biggest economies, has frustrated investors.
The European Central Bank disappointed markets by buying Irish and Portuguese bonds but not government paper in Italy and Spain where bond yields have blown out this week on fears they may need bailing out.
That now appears to have been a gambit to force Italy to act.
In principle it is right to say that the ECB could start buying Spanish and Italian bonds if they made an extra effort with fiscal and structural reforms, a senior euro zone official told Reuters.
Bank of Spain governor Jose Manuel Gonazalez-Paramo, a member of the ECB's governing council, said he expected Spain to announce further measures on August 19 to ensure it meets its budget austerity targets.
Earlier in the day, China and Japan called for coordinated action to avert a new worldwide crisis sourced to Europe and the United States, as did Rehn.
International policy coordination through the G7 and G20 is of critical importance, he told a news conference, having broken off his vacation and returned to Brussels.
Britain called for a concerted international effort to show governments would work together to avert a financial crisis and Brazil also urged unity, saying the world economy was in a situation of stress.
(Additional reporting by Paul Taylor in Paris, Kathrin Jones and Sakari Suoninen in Frankfurt, Leika Kihara in Tokyo, William James, Jeremy Gaunt and Ana Nicolai da Costa in London, Pedro da Costa, Kristina Cooke, Walter Brandimarte and Lucia Mutikani in New York and Emily Kaiser in Singapore; writing by Paul Taylor, Barry Moody, Mike Peacock and Martin Howell; editing by Dean Yates)