17/01/2012 12:40 GMT

Eurozone Crisis: Markets Shrug Off Downgrades As Germany Shows Glimmers Of Hope

European markets appeared to shrug off a rash of downgrades by the rating agency Standard & Poor's on Tuesday, as improvements in Germany's economic sentiment and the prospect of continued growth in China added to a surprisingly upbeat day in the eurozone.

S&P downgraded the sovereign ratings of nine eurozone countries on Friday, and of the European Financial Stability Facility (EFSF), the eurozone bailout fund, on Monday.

European stocks hit a five-month high, with the FTSE-100 up 0.6% at the close, while the French CAC-40 and the German DAX rose 1.18% and 1.64% during the day.

Despite their respective downgrades, both the Spanish government and the EFSF held relatively successful debt auctions.

Spain, dropped by two notches by S&P on Friday from AA- to A, sold €4.88bn (£4.05bn) in 12- and 18-month bonds on Tuesday, with yields - the amount of interest that investors demand on the assets - of 2.049% and 2.399%, respectively. Yields fell by nearly half from a similar auction a month ago.

The country faces a bigger test later in the week, when it holds an auction of 10-year bonds, offering an insight into how investors see the country's long-term economic future.

The EFSF, downgraded on Monday from AAA to AA+, sold €1.5bn in six month bills in an auction which was more than three times covered - bids for the fund's bonds totaled €4.66bn.

The downgrades did not come as a surprise to markets, and so their impact was limited, Adam Smears, head of research at Skandia Investment Group (SIG), told the Huffington Post UK.

The S&P downgrades have effectively been in the market price since December, when it was first mooted that France would lose its AAA rating. Markets do tend to anticipate rating agency action rather than reacting to it," Smears said.

"Equity markets, credit markets and sovereign yields remained relatively stable in the wake of the announcement which implies the market had already had a more negative view on the sovereign situation than policy makers or ratings agencies. Potentially a bullish signal as it shows the market is pricing more risk."

Better news came out of Germany. The influential ZEW economic sentiment survey came out strongly positive, with the indicator soaring to the highest it has been since last July, before the crisis spiraled to engulf the entire eurozone.

The survey, conducted by the Centre for European Economic Research in Mannheim, collates analyst and investor expectations, and appears to suggest that the economy will avoid recession.

An easing in credit conditions that followed the European Central Bank's release of hundreds of billions of euros in short-term loans, and the subsequent reduction in the cost of borrowing for the Italian and Spanish governments may have contributed to the improvement in sentiment, the institute said.

"Contrary to repeatedly expressed fears of a recession the assessment of the financial market experts gives reason for cautious optimism that Germany will only experience a dent in economic activity," ZEW's president, Professor Wolfgang Franz, said in a statement accompanying the survey data.

"The generous supply of liquidity by the ECB and the relatively affordable refinancing terms for Italy and Spain may have supported the improvement of this month’s sentiment. Nonetheless, the further development of the debt crisis remains a risk to economic growth,"

Further afield, Chinese growth figures were better than many had hoped, giving hope that the world's second largest economy will continue as an engine of consumption for developed world goods. Automotive manufacturers and mining companies saw their shares rise in response, pulling up European stock markets.

Despite the positive indicators, there are some massive challenges ahead. Negotiations between Greece and its private sector creditors resume on Wednesday, with the country's ability to stave off default in the balance. The country is seeking to cut €100bn from its debt mountain, but talks with the private sector broke down on Friday evening.

Greece's next bailout package is contingent on it first coming to an agreement on the so-called "private sector involvement" (PSI). Without that bailout, the country is likely to default.