George Osborne has come under attack over what Labour calls his "catastrophic economic policy failure" after the UK lost its top-grade AAA credit rating.
International agency Moody's downgraded it by one notch to AA1, citing slow growth and a rising debt burden.
The Chancellor said the coalition would not "run away" from its economic problems and it was determined to stick by its plan for recovery.
The downgrade is a major blow for Mr Osborne, who has been coming under increasing pressure to take action to stimulate the economy.
In the last election, Mr Osborne made safeguarding Britain's credit rating one of his key pledges.
He has used maintaining the rating for government bonds as one of the main arguments for the Government's austerity programme.
The Chancellor insisted the Government was delivering on its commitment to tackle the UK's debt.
He said: "We have a stark reminder of the debt problems facing our country - and the clearest possible warning to anyone who thinks we can run away from dealing with those problems.
"We are not going to run away from our problems, we are going to overcome them."
He added: "In the end, the test of our credibility as a country is there every day in the markets when we borrow money on behalf of this country from investors all around the world.
"At the moment we can do that very cheaply with very low interest rates precisely because people have confidence that we have got a plan, we've got to stick to that plan and we are going to deliver that plan."
Labour's shadow chancellor Ed Balls told Sky News: "They (the Government) are paying the price for an absolute catastrophic failure of economic policy and everybody can see that now pretty much other than the chancellor and the prime minister.
"Until they face up to reality, we're just going to have more of the same."
Moody's said Britain's recovery was proving to be significantly slower than previous rebounds from recession and it did not expect the situation to change.
"(There's) increasing clarity that, despite considerable structural economic strengths, the UK's economic growth will remain sluggish over the next few years," it said.
Moody's is the first of the major credit rating agencies to knock the UK off of its top rating.
The ratings agency also cut the Bank of England's AAA rating by one notch, also to AA1. The US' top credit rating was downgraded by one notch in 2011.
Sky's Economics Editor Ed Conway said: "The fact that Britain has lost its AAA crown for the first time since credit ratings were given to the UK back in the 1970s, is a really big blow to Britain's reputation.
"It's something of an economic blow, but in a way it's more of a political problem for George Osborne. He made a key part of the Conservative election pledge to safeguard Britain's credit rating."
Moody's said that the British economy is constrained both by the troubled global economy and the drag from businesses and the Government slashing its debt burdens.
"Moreover, while the Government's recent Funding for Lending Scheme has the potential to support a surge in growth, Moody's believes the risks to the growth outlook remain skewed to the downside," it said.
Labour has insisted that withdrawing demand from the economy has put it more at risk by stunting growth.
Mr Balls said: "This credit rating downgrade is a humiliating blow to a prime minister and chancellor who said keeping our AAA rating was the test of their economic and political credibility.
"In the Budget the government must urgently take action to kick-start our flatlining economy and realise that we need growth to get the deficit down. If David Cameron and George Osborne fail to do so and put political pride above the national economic interest we face more long-term damage and pain for businesses and families."
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