Nine Euro Nations’ Ratings Cut

France and Austria lost their top credit ratings at Standard & Poor's in a swathe of downgrades that left Germany with the euro area's only stable AAA grade, hindering leaders' efforts to stem the region's fiscal crisis.

France and Austria were cut one level to AA+ from AAA and face the risk of further reductions, the rating company said in Frankfurt today. While Finland, the Netherlands and Luxembourg kept their AAA ratings, they were put on negative watch. Spain and Italy were also downgraded. The first gauge of the report's impact will come on Jan. 16 when France sells as much as 8.7 billion euros ($11 billion) in bills.

“In our view, the policy initiatives taken by European policy makers in recent weeks may be insufficient to fully address ongoing systemic stresses in the euro zone,” S&P said in a statement.

S&P acted at the end of a week in which signs grew that Europe's woes may be cresting as borrowing costs fell, evidence of economic resilience emerged and the European Central Bank said it had quelled a credit crunch at banks. While France's downgrade may make it harder for the euro region's bailout fund to raise money in financial markets, the immediate impact on French and Italian bond yields was muted.

“I'm not convinced that the downgrades will have a massive market impact,” said Jonathan Loynes, chief European economist at Capital Economics Ltd. in London. “It does further underline the fact that the fiscal crisis is no longer confirmed just to the small peripheral economies.”

European leaders are struggling to tame a crisis now in its third year and convince investors they can restore budget order. Greece's creditors today suspended talks with its government having failed to agree with its authorities about how much money investors will lose by swapping the nation's bonds, increasing the risk of the euro-area's first sovereign default.

The euro today fell to its weakest in 16 months against the dollar, declining to $1.2665. The yield on Germany's benchmark 10-year bund slipped 7 basis points to 1.759 percent and earlier touched a record low.

Regional finance ministers sought to play down S&P's decision or turn it to their advantage as European leaders prepare to meet for the first time this year on Jan. 30.

“It's not a catastrophe,” French Finance Minister Francois Baroin told France 2 television, noting his country now has the same rating as the U.S.

Schaeuble's Comments

Wolfgang Schaeuble, his German counterpart, said the shifts vindicated governments' decision last month to bring forward a permanent bailout fund to this year from 2013 and strengthened Germany's determination to stabilize the euro region by instilling stricter budget discipline.

“We know that there's uncertainty with respect to the euro area,” he told reporters in the northern German port city of Kiel.

The French and Austrian downgrades threaten the potency of the region's current rescue program, which currently has a capacity of 440 billion euros ($558 billion). The European Financial Stability Facility, which is funding rescue packages for Greece, Ireland and Portugal partially with bond sales, owes its AAA rating to guarantees from the region's top-rated nations.

The French downgrade and refusal by governments to provide more credit enhancements would still reduce the fund's lending capacity by around a third to 293 billion euros, Trevor Cullinan, S&P's director of sovereign ratings, said last month.

“It will be interesting to see what the strategy will be regarding the EFSF,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London. Downgrades could “limit the volume of AAA-rated EFSF paper that could be issued, or the EFSF could begin to issue non-AAA.”

Downgrades sometimes lack bite. The yield on the benchmark U.S. government bond fell to a record 1.6714 percent on Sept. 23, seven weeks after S&P withdrew its AAA rating for the first time, citing the nation's political process and a failure to tackle a record budget deficit.

The impasse in Greece's debt-swap talks comes three months since officials and creditors agreed to implement a 50 percent cut in the face value of the country's debt, with a goal of paring Greek's borrowings to 120 percent of gross domestic product by 2020. Unresolved is the coupon and maturity of the new bonds to determine the total losses for investors.

Greek Impasse

Proposals put forward by a committee representing financial firms have “not produced a constructive consolidated response by all parties,” the Washington-based Institute of International Finance said in a statement today. “Discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach.”

The government said the two sides will reconvene discussions in five days. European governments have been pushing for the Greek debt to carry a coupon of 4 percent, a person with direct knowledge of the negotiations said this week. Private bondholders said they would accept those terms for a period of time if they were able to get a bigger payout later as Greece's economy recovered, the person said.

The Greek bond due October 2022 rose, pushing the yield six basis points lower to 34.36 percent at 5:20 p.m. London time. The price climbed to about 20.5 percent of face value.

The French downgrade strikes a blow to President Nicolas Sarkozy's bid for re-election after he sought to protect his government's creditworthiness by announcing tax increases and spending cuts. He trails his main rival, Socialist Party candidate Francois Hollande, by about 14 points in voting intentions for the second round of the election in May, according to a BVA poll for Le Parisien newspaper published Jan. 9.

Prior to S&P's announcement investors had eased the costs they were imposing on Italy and Spain to borrow, sparking speculation the worst of the crisis may be passing. ECB President Mario Draghi said yesterday the central bank had averted a serious credit shortage and economy is stabilizing with data showing rebounds in German exports and French business confidence.

“The markets were due a pullback considering the bullishness we have seen this week looked overdone,” said Richard Driver, an analyst for Caxton FX.

Bloomberg News

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