May 21 (Bloomberg) -- The pound dropped from a six-month high versus the dollar after Standard & Poor’s signaled Britain may lose its top credit rating for the first time as the government’s finances deteriorate during the economic slump.

Sterling pared its decline on speculation a downgrade wasn’t imminent and two other rating companies affirmed the U.K.’s “stable” outlook. The dollar rose from a four-month low against the euro after former Federal Reserve Chairman Alan Greenspan said yesterday the financial crisis isn’t over, increasing demand for the greenback as a haven.

“Short-term longs are taken out,” said Richard Benson, who oversees $14 billion of currency funds at Millennium Asset Management in London. “Anyone who bought the pound and didn’t know this problem shouldn’t be trading currencies. This is a well-documented story.” A long position is a bet that a currency will gain.

The pound fell 0.2 percent to $1.5722 at 11:48 a.m. in New York, from $1.5755 yesterday, earlier touching $1.5817, the highest level since Nov. 10. Sterling weakened 0.2 percent to 87.66 pence per euro from 87.48.

The dollar traded at $1.3779 per euro, compared with $1.3780, after touching $1.3839, the weakest level since Jan. 5. The dollar gained 0.2 percent to 95.10 yen from 94.88. The euro advanced 0.2 percent to 131.07 yen from 130.77.

S&P lowered the outlook on the U.K.’s AAA rating to “negative” from “stable.” Moody’s Investors Service said in a statement today that the U.K.’s top Aaa sovereign credit rating remains unchanged with a “stable” outlook because the government can absorb and reverse the debt burden “over time.” Fitch Ratings reaffirmed its AAA credit grade for the U.K. with a “stable” outlook.

U.K. Deficit

The U.K.’s budget deficit this year will reach 175 billion pounds, or 12.4 percent of gross domestic product, Chancellor of the Exchequer Alistair Darling said on April 22.

Credit-default swaps, which provide insurance for bondholders against potential defaults, rose 6.5 basis points, or 0.065 percentage point, to 79 basis points on U.K. sovereign debt, according to CMA DataVision prices. The CDS price for Spain, which lost its AAA rating in January, was quoted at 82.5.

“If you look at the CDS, it tells you it’s already reflected in the price,” said Benson.

Even after S&P cut its outlook, the government sold all 5 billion pounds ($7.9 billion) of five-year bonds it offered at an auction today.

‘Auction Went Well’

“The move does not mean a downgrade is inevitable,” Shaun Osborne and Jacqui Douglas, currency strategists at TD Securities Inc. wrote in Toronto, in a research note today. “The auction went well. The markets appear to be casting around for other countries that may be facing a similar fate, and clearly the U.S. is the elephant in this particular room.”

The administration of President Barack Obama will issue a record $3.25 trillion of debt in the fiscal year ending Sept. 30, according to Goldman Sachs Group Inc. The U.S. Treasury reported the first budget deficit for April in 26 years, recording a $20.9 billion shortfall.

Britain would become the fifth western European Union nation to lose its rating because of the economic slump, following Ireland, Greece, Portugal and Spain. The U.K. plans to sell a record 220 billion pounds of bonds in the fiscal year through March 2010 as the recession cuts revenue and forces the government to raise spending.

The government gave the Bank of England authority to purchase as much as 150 billion pounds of assets with newly printed money in an attempt to lower borrowing costs.

Pound Versus Dollar

The pound gained 5.7 percent versus the dollar this month and 1.8 percent against the euro as Britain’s retail sales increased and the housing market showed signs the worst of the slump may be over.

The dollar advanced after Greenspan said yesterday in an interview in Washington that U.S. banks need to raise “large” amounts of money.

“We’re on the edge, and if this thing doesn’t get resolved quickly I’m worried,” Greenspan said.

The euro earlier gained versus the dollar after a report showed Europe’s manufacturing industry contracted at the slowest pace in eight months.

An index based on a survey of manufacturers rose to 40.5 in May from 36.8 in April. The median estimate in a Bloomberg survey of 33 economists was for a reading of 38.3. A reading below 50 indicates contraction.

The dollar earlier dropped to a two-month low against the yen amid speculation the Federal Reserve will print more cash to boost purchases of assets to counter the global slump.

Yen Call Options

Traders are paying a larger premium for yen call options against the dollar, which grant the right to buy Japan’s currency, over puts that provide the right to sell it. The premium on yen calls over yen puts rose to 2.43 percent today from 2.22 percent yesterday.

Some Fed policy makers, when they met April 28-29, indicated the central bank might have to build on its plan in March to buy assets including up to $300 billion of Treasuries should the economy or financial markets deteriorate further.

“The dollar’s weakness reflects growing concern about the fiscal sustainability of the policy response to the crisis,” Todd Elmer, a currency strategist at Citigroup Inc. in New York, wrote in a report today.

To contact the reporters on this story: Anna Rascouet in London at arascouet@bloomberg.net To contact the reporter on this story: Ye Xie in New York at yxie6@bloomberg.net

Last Updated: May 21, 2009 11:56 EDT