By Jamie McGeever and Ian Chua
LONDON, June 8 (Reuters) - Britain and Austria could be the European countries whose sovereign credit ratings are most likely to be cut next after Standard & Poor's lowered Ireland's rating on Monday for the second time in only three months.
Of those two, Britain is the only one with its sovereign credit rating on "negative" watch, suggesting if S&P is to cut another sovereign it's the UK triple-A rating that could go.
The sheer scale of UK government borrowing and projected deficits over coming years, coupled with the banking sector's growing liabilities, mean a downgrade could be on the cards if policy steps fail to impress the ratings agencies.
Austria still has its triple-A rating and is on "stable" outlook. But that could change if financial and economic turmoil in the Baltics and Eastern Europe, to which Austrian banks have large exposure, deepens.
"The UK is a point of reference. If S&P is worried about Ireland's exposure to banks, it could well be worried about UK's exposure to banks," said Ciaran O'Hagan, senior strategist at Societe Generale in Paris.
Britain will borrow 175 billion billion pounds this fiscal year and the budget deficit will swell to a record 12.4 percent of GDP.
O'Hagan noted that "contingent liabilities" of the UK financial sector, mostly banks', are estimated at almost 30 percent percent of gross domestic product and will almost certainly rise this year.
"S&P could take action on the UK," he said.
In cutting Ireland's sovereign credit rating to "AA" with a negative outlook from "AA+", S&P warned it could fall further because of concern about the soaring cost of bailing out the country's banking sector.
"The rating could be lowered again if asset quality in the Irish banking system deteriorates at a faster pace than we expect," S&P said in a statement.
For more, see.
Currency strategists at Swiss bank UBS agreed that the difficulties facing British banks could sour sentiment towards Britain.
"The downgrade does not bode well for the UK as S&P cited the government support for the financial sector as a key weakness in Ireland. Within Europe, only the UK is in a similar predicament and any spillover effects from Ireland would weigh on sterling," they said in a note.
AUSTRIA'S CEE EXPOSURE
So far this year in the realm of highly-rated European sovereigns, S&P has downgraded Ireland, Spain, Portugal and Greece and revised the outlook on the United Kingdom to negative.
Greece, Portugal and Spain have stable outlooks from S&P, while Ireland and Britain have negative outlooks.
Although Austria retains a stable outlook on its "AAA" rating, ratings agencies said in February they were keeping a close eye on it due to the country's exposure to emerging Europe, even though Austria's budget has some leeway to tackle the fallout from the financial crisis.
But problems in emerging Europe flared up again recently, notably in Latvia where since-denied speculation of a currency devaluation to cushion an 18 percent fall in output helped push overnight interbank rates rates to a whopping 30 percent.
"Austria is a bit at risk, especially after events of past weeks which again brought CEE (Central and Eastern Europe) issues into the spotlight," said Michael Leister, strategist at WestLB in Dusseldorf.
"Given that it's a constant source of trouble and no one really has a clue how to solve it, it's quite fair if you look at it at the moment, that they (Austria) may be next in line," he said, adding that the cost to Austria of supporting its local banking sector might be underestimated.
Austrian/German 10-year government bond yield spreads widened last week by around 20 basis points to a month-high of around 81 basis points, as investors dumped Austrian bonds.
Tuesday's auction of Austrian bonds will be a further gauge of investor appetite for the country's paper. Austria is due to sell 935 million euros of July 2015 bonds and 1.1 billion euros 2019 bonds. (Editing by Stephen Nisbet)