UK warned of credit downgrade

Fears that inflation and eurozone infection will lead to Britain losing its triple-A rating

The UK will lose its prized triple-A credit rating next year as a result of the recession and the euro crisis, according to one of the City's most respected bond fund managers.

Richard Hodges, the manager of the Legal & General dynamic bond trust, said in the light of the euro sovereign debt crisis: "The question isn't will the UK be downgraded, but when? The ratings agencies haven't moved partly because they have bigger fish to fry. But as this crisis plays out it is inevitable that they will downgrade the UK, with its huge current account deficit, by 2013 at the latest."

The Bank of England's additional round of quantitative easing this year has contributed to inflation coming in well above target and makes a downgrade even more likely.

Mr Hodges told The Independent on Sunday: "The UK is inflating itself out of its debts. It's a slow default by the back door and that will be reflected in the credit rating sooner rather than later."

Phil Milburn, the co-manager of the Kames Capital strategic bond fund, agrees that the UK is under fresh pressure. He said: "I wouldn't say a downgrade is a certainty, but there is no value in UK government stock. It's a rigged market. Add the size of the current account deficit, lower tax take and the cross-current from the eurozone, and it only points one way – a downgrade."

Any renewed pressure on the triple-A rating will be a body blow to the Chancellor George Osborne, who has made hanging on to the gold standard central to his strategy. Britain was put on watch in February when credit rating agency Moody's warned it could downgrade it, a measure that would drive up borrowing costs.

Meanwhile, Spanish banks, including the parent of UK high street stalwart Santander, were downgraded en masse by Moody's last Thursday, which led to higher than normal withdrawals. Mr Hodges said: "Spanish banks are the most bust in the world. They are only now facing up to potential losses from corporate loans to commercial real estate. The US did this four years ago and UK two years ago."

On Friday, the Spanish government appointed Goldman Sachs to audit the recently nationalised Bankia which is believed to be facing a €18bn (£15bn) loss on property lending and will need government and perhaps EU cash to recapitalise. European finance officials have also persuaded the Spain to audit its entire banking sector.

A Santander UK spokesman said problems in Spain would have "no impact on the UK or future growth plans".