Eurozone Crisis: France And Austria Downgraded by S&P
The rating agency Standard & Poors (S&P) has downgraded the sovereign ratings of France and Austria from AAA in a move that highlighted the fragility of confidence in the single currency area, despite a relatively quiet start to 2012.
Throughout Friday, rumours that the downgrade for France and other eurozone countries was imminent drove stock markets and the euro down. Austria and France have been downgraded a notch while Italy's has fallen to BBB+, according to Sky reports.
French finance minister Francois Baroin called the downgrade "bad news" but maintained it was not "a catastrophe".
"You have to be relative, you have keep your cool. It's necessary not to frighten the French people about it," he said.
S&P said its actions were "primarily driven by our assessment that the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone".
In a statement it added: "The outlooks on the long-term ratings on Austria, Belgium, Cyprus, Estonia, Finland, France, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia, and Spain are negative, indicating that we believe that there is at least a one-in-three chance that the rating will be lowered in 2012 or 2013."
Economic Affairs Commissioner Olli Rehn declared in a statement: "I regret the inconsistent decision by Standard & Poor's concerning the rating of several euro area member states, at a time when the euro area is taken decisive action in all fronts of its crisis response.
"These initiatives push forward the necessary fiscal consolidation and structural reform in our member states, address the fragilities of the banking sector, reinforce our financial backstops and strengthen our economic governance.
"The recent EU decisions, combined with action by the European Central Bank, CB, have been instrumental in easing tensions in sovereign bonds markets."
Mr Rehn said it was now important to finalise the details of a new bail-out plan for struggling eurozone economies so that it can come into force in July this year.
Twenty-six member states are trying to finalise a new "fiscal compact" to tighten controls on eurozone debt and deficit levels, but Mr Callanan said: "If European leaders really want to save the euro, they need to listen to what the markets have already told them: it is time for some countries to leave the single currency. The longer we dither and obfuscate, the worse the crunch will be."
He added: "The EU summit at the end of this month really is the last chance saloon for an injection of realism from EU leaders. If we see yet more discussion of treaties, bailout mechanisms and attacks on financial services then I fear we will soon pass the mark where we can salvage anything from the wreckage."
In August, S&P stripped America of its cherished triple-A credit rating for the first time in its history because the deficit reduction plan passed by Congress did not go far enough to stabilise the country's debt situation.
The UK has so far clung on to its top rating but a recent report by rating agency Moody's said the eurozone debt crisis had increased the risk of a downgrade.
Reports of the downgrade began on French television channels, and spread on the Reuters and Dow Jones newswires, all quoting unnamed government sources. S&P has consistently declined to comment. The French newspaper, Les Echos, said that the country's downgrade would be a single notch.
French President Nicolas Sarkozy cuts a lonely figure as he walks in the lobby of the Elysee Palace following a meeting with his finance minister Francois Baroin
Fifteen eurozone countries have been on ratings watch since December 5, so the bond market reaction was not dramatic, with analysts and traders saying that the downgrade had been largely priced in already. French bond yields drifted up to just over 3%, and Italian bonds were at 6.62% mid afternoon, up from the previous day but still some way off their highs of last year.
"I think people have been expecting it," Mike Franklin, head of investment strategy at Beaufort International Associates, said. "I don't think it will come as a shock to people."
"I think where there is grounds for caution is that there is a knock-on, because holders of French government debt may come under pressure to let it go because it's not rated as highly as it has been."
European banks are major holders of the country's bonds, and many have already come under pressure for their perceived weakness and low levels of available capital. Those banks may struggle to raise capital if their own creditworthiness is questioned in light of the sovereign downgrade.
However, the euro fell by 1.38%, its biggest intraday change since August 2010, and stock markets were pushed down. The FTSE-100 was down 0.79%, while the French CAC-40 and the German DAX had fallen 0.96% and 0.56%, respectively, by 4pm GMT. However, the British and French markets rallied at the close, with the CAC-40 off 0.11% and the FTSE-100 down 0.46%. The DAX held onto its losses and closed down 0.58%.
"We all knew S&P was going to get its axe out but it has come a little sooner than expected and it only reinforces our bearish view on the single currency," Richard Driver, analyst at Caxton FX, said in an email.
"It sounds like Germany's AAA-rating will be left alone, which is a relief, but this French downgrade is a major development if it’s confirmed - Sarkozy will be furious."
While anticipated, a downgrade to the eurozone's biggest sovereigns could be significant, as it would likely lead to a downgrade to the European Financial Stability Facility (EFSF), the bailout fund, which raises capital by issuing bonds, like a country. It is backed by the AAA-rated countries in the eurozone, and its cost of borrowing is linked to theirs.
The fund has already struggled to raise capital, and if its cost of borrowing rises too far, it may become less viable as a bailout mechanism. That, in turn, would put further pressure on the eurozone's sovereign countries, as a vital safety net for them would be weakened.
Earlier, Spain sold 10bn euros worth of bonds, twice its intended target, with yields across a number of debt maturities down, indicating that the market has regained some confidence in the country's ability to pull itself out of its current mire. Italy raised 4.75bn euros in short-term debt, with yields again falling.
The European Central Bank (ECB) released more than 400bn euros in short-term loans to the banking sector at the end of December, flooding the market with liquidity in the hope that the money will be used to buy up sovereign debt in Spain, Italy and other peripheral countries. Friday's auctions suggest that this has happened to some degree, although much of the cash has been used to boost banks' balance sheets, analysts said.
Effective or otherwise, the ECB's initiative has not solved the structural problems in those countries, and with concerns over Greece still very present, some are warning of an imminent default.
While they were overshadowed by the S&P rumours, meetings between the Greek government and the Institute of International Finance (IIF), which is negotiating on behalf of private sector holders of Greek debt, appeared to be on the brink of collapse on Friday night. Greece needs to agree on a voluntary write-down, or "haircut" with bondholders in order to be able to move back towards solvency. The 50% haircut that was agreed in October is no longer seen as being sufficient, so the government has been hoping to arrange an even larger write-down. Without an agreement, a default would be almost unavoidable.
"The [Spanish and Italian] auctions actually went pretty well... At least they now appear to be trying and getting a grip of the problem," Franklin said.
"That having been said, I think we are going to see some of the weaker members really having to think very hard about having to come out of the euro. It's rumbled on for so long now that I don't think it'll come as a shock to anyone."
According to UK Independence Party leader Nigel Farage suggested the latest round of downgrading could mean "the beginning of the end" for the eurozone.
"Now that France has been downgraded I expect the bond yields of countries like Italy and Spain to rise, leading to a need for a bailout and more trouble for the Euro currency," he said.
"The euro currency - the ultimate Federalist fantasy - has become a nightmare for those caught in its embrace."