The City reacted with dismay today as Britain's “safe as houses” credit rating came under threat for the first time.

A major report into the economy said ballooning government debt meant that Britain faces expulsion from the elite club of the world's most financially stable countries.

The report from ratings agency Standard & Poor's sent a wave of fear through the City, making it one of the worst days for the economy for weeks.

The pound dropped like a stone, falling more than one per cent against both the euro and the dollar.

The FTSE-100 plummeted after the announcement, at one point standing 127 points down at 4342.12, although it later recovered some ground.

Official figures showed public borrowing soared to almost £8.5 billion in April, a record public deficit for the month.

The encouraging recovery in mortgage lending came to a juddering halt with a nine per cent fall last month.

Although Britain has kept its gold-plated AAA rating for now, Standard & Poor's has downgraded its stance on the rating from “stable” to “negative”.

S&P said that if, as expected, public debt exceeds 100 per cent of GDP over the next few years, Britain would be stripped of its AAA status.

S&P credit analyst David Beers said: “The rating could be lowered if we conclude that, following the election, the next government's fiscal consolidation plans are unlikely to put the UK debt burden on a secure downward trajectory over the medium term.”

A downgrade from AAA would be a financial disaster for Britain and shatter the last vestiges of Gordon Brown's reputation for fiscal prudence.

Britain's rating has never been downgraded since the system was introduced in 1978 and only the basket-case economies of Ireland, Greece, Portugal and Spain have been downgraded in Europe since the start of the credit crunch.

A downgrade would make it far harder for the Treasury to fund the massive borrowing programme needed to pay for public spending and the bank bail-out, forcing interest rates to rise and prolonging the recession. The Government has said it will need to issue £220 billion of gilts this year. The news came just a day after the International Monetary Fund said the recovery in the UK is likely to be subdued and called on the Government to do more to repair public finances.

City analysts said it was “a shot across the bows” for the Treasury which could lead to even bigger tax rises and deeper spending cuts than feared.

Colin Ellis, an economist at Daiwa Securities, said: “Whoever wins the next election, tax hikes and sharp spending cuts will be the order of the day, but today's announcement by S&P puts that much more pressure on the next government to act quickly.”

New official data shows a shocking deterioration in the public finances.

The recession has sharply reduced government tax receipts, especially from the corporate sector and bonus payments, while the Government is having to pay out more in benefits as unemployment continues to rise.

Kenneth Broux, an economist at Lloyds TSB Corporate Markets, said: “This is a reality check. S&P think the recession means more red ink and the latest borrowing estimates are unsustainable.”

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