Moody's Investors Service said Thursday there is a very small but rising risk of a short-lived default by the United States if the country's debt limit is not increased in coming weeks.

In a statement, Moody's said it would put the Aaa U.S. credit rating on review for a possible downgrade if lawmakers in Washington do not make substantive progress in budget talks by the middle of July.

Since the risk of continuing stalemate has grown, if progress in negotiations is not evident by the middle of July, such a rating action is likely, Moody's said.

The rating outlook is stable whereas Standard & Poor's in April revised to negative its credit outlook on the U.S. rating, citing similar concerns over political wrangling in Washington over what many consider are unsustainable levels of U.S. debt.

The heightened polarization over the debt limit has increased the chances of a short-lived default. If this situation remains unchanged in coming weeks, Moody's will place the rating under review, the firm said.

Without a debt limit increase, either on August 2 or some later date, U.S. Treasury Secretary Timothy Geithner likely would have to make decisions on which bills to pay. He could decide to delay Social Security benefit payments to retirees, withhold military pay, sell some government assets or not pay off government bond-holders.

The U.S. deficit is expected to reach $1.4 trillion this year. The debt ceiling is currently $14.3 trillion.

The ratings agency said if the debt limit is raised and default avoided, the Aaa rating will be maintained. Still, the rating outlook will depend on the outcome of the debt talks, Moody's said.

Moody's downgrade adds pressure on Congressional leaders to work hard at reaching an agreement to increase the debt ceiling, said Kathy Lien, director of currency research at GFT Forex in New York.

If a downgrade were to occur, Moody's said it would put the U.S. credit in the Aa range.

A face-to-face meeting is a chance for Geithner to make the case that the debt-limit vote is needed to address spending that has already been incurred and that with financial markets already shaky, a failure to lift the ceiling could further unsettle investors and risk grave harm to the economy.

I think there is some consternation in terms of how politicians are going to play out the debt ceiling between now and August 2, said Fred Dickson, chief market strategist at D.A. Davidson & Co in Lake Oswego, Oregon.

We're in a period of above-average volatility, and I think this will probably add to that.

(Additional reporting by Nick Olivari; Editing by James Dalgleish)

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