The outlook revision does not trigger a formal re-evaluation of Britain's rating - unlike being put on credit watch - but does mean that policy makers have to be aware that a downgrade may happen if public finances do not improve.
The pound slumped by over 2 U.S. cents to just below $1.56 after the news, but recovered some ground to trade around $1.5670. Meanwhile the FTSE share index fell more than 120 points, or around 2.7 percent, though like other markets around the world it was facing heavy selling pressure after the U.S. Federal Reserve warned that the U.S. economy would shrink by more than anticipated this year.
A lower credit rating would make the government pay higher interest rates to borrow money on bond markets. An S&P study found that 37 percent of its negative outlooks were followed by a downgrade.
"Pressure on the rating will raise concerns regarding the ability to issue the record amount of gilts (British government bonds) required over the coming year to fund the deteriorating fiscal position in the U.K.," said Hans Redeker, an analyst at BNP Paribas.
This is the first time Britain has been put on the negative list since since S&P started giving its view of the outlook of the country's public finances in the early 1980s.
S&P said the downward revision reflects a more cautious view of how quickly the country's finances can be repaired and that its projections incorporate new estimates of the cost of the government's bailout of the banking sector. It now esimtates that the government's net debt burden will rise to nearly 100 percent of economic output by 2013, way more than the government is currently projecting.
"These projections reflect our more cautious view of how quickly the erosion in the government's revenue base may be repaired, the extent to which the growth in government spending can be curtailed, and consequently the pace at which historically high fiscal deficits are likely to narrow," said S&P's credit analyst David Beers.
"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," Beers said.
Prime Minister Gordon Brown is under pressure to call a general election from the Conservative Party leader David Cameron to deal with a mounting controversy over expense-account abuses in Parliament. Brown still has a year before an election must be held, but all opinion polls show that the country's swelling debt burden is one of the voters' major concerns.
Figures earlier highlighted the scale to which Britain's public finances have deteriorated.
The Office for National Statistics said public sector net borrowing - the government's preferred measure - jumped to 8.5 billion pounds in April from 1.8 billion in the same month the year before as the country pays for higher social welfare benefits and sorts out the banks.
In his budget last month, Britain's finance chief Alistair Darling predicted that the country's debt position, which aggregates borrowing through the years, is expected to rise to 59 percent of gross domestic product in 2009-10, rising to a peak of 79 percent in 2013-14. When the government came into office in 1997, it said one of its main economic policies was to keep debt around 40 percent.
The statistics office said earlier that net debt stood at 53.2 percent of GDP at the end of April.
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