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Mass downgrade of eurozone countries

Last updated 12:08 14/01/2012

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Ratings agency Standard & Poor's dealt a setback on Friday (Saturday NZT) to Europe's ability to fight off a worsening debt crisis by downgrading the government debt of France, Italy, Spain and Austria. But it kept Germany's at the coveted AAA level.

All told, S&P cut its ratings on nine eurozone countries.

The downgrades could drive up yields on European government debt as investors demand more compensation for holding bonds deemed to be riskier than they had been. Higher borrowing costs would put more financial pressure on countries already contending with heavy debt burdens.

The rating agency ended France and Austria's triple-A status. It also lowered Italy's and Spain's by two notches and did the same for Portugal and Cyprus. S&P also cut ratings on Malta, Slovakia and Slovenia.

"In our view, the policy initiatives taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone," S&P said in a statement.

France's downgrade to AA+ lowers it to the level of US long-term debt, which S&P downgraded last summer.

S&P had warned 15 European nations in December that they were at risk for a downgrade.

France is the second-largest contributor behind Germany to Europe's financial rescue fund. The fund still has a rating of AAA. That means that it can borrow on the bond market at low rates.

Some analysts downplayed the impact of the downgrades.

"It's going to create bad headlines for a day or two," said Jacob Funk Kirkegaard, research fellow at the Peterson Institute for International Economics. But "there's no underlying new information ... This will be quickly forgotten."

Still, the cut in the French credit rating may lead bond traders to raise borrowing costs for the financial rescue fund, said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott, a financial firm.

"There's a legitimate reason to be concerned," he said. "A weaker France means a weaker bailout fund."

Stocks fell on Friday as downgrade rumours reached the trading floors of Europe and the United States. But the declines were nothing like the wrenching swings of last summer and fall, when the debt crisis threw the markets into turmoil.

The Dow Jones industrial average in New York was down 0.5 per cent. Stocks fell 0.6 per cent in Germany, 0.5 per cent in Britain and 0.1 in France, but each of those markets closed before Baroin made his announcement on French television.

Borrowing costs for the French government rose before the announcement. The yield on France's 10-year government bond rose to 3.1 per cent from 3 per cent earlier. That is still less than the 3.36 per cent rate on the same bond last week and far below the 6.6 per cent that Italy has to pay to borrow money from bond investors for 10 years.

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Germany, the strongest economy in Europe, pays a yield of just 1.76 per cent. The United States 10-year Treasury note paid 1.85 per cent on Friday, down 0.08 percentage points - a sign that investors were seeking safety in US debt.

Speaking on France-2 Television, French Finance Minister Francois Baroin said the downgrade of France's AAA sovereign debt rating was not "a catastrophe". He underscored that France still had a solid rating.

"The United States, the world's largest economy, was downgraded over the summer," Baroin said. "You have to be relative, you have keep your cool. It's necessary not to frighten the French people about it."

Earlier Friday, the euro hit its lowest level in more than a year and borrowing costs for European nations rose. Stock markets in Europe and the US fell.

Fears of a downgrade brought a sour end to a mildly encouraging week for Europe's heavily indebted nations and were a stark reminder that the 17-country eurozone's debt crisis is far from over.

Earlier Friday, Italy had capped a strong week for government debt auctions, seeing its borrowing costs drop for a second day in a row as it successfully raised as much as euro4.75 billion.

Spain and Italy completed successful bond auctions on Thursday, and European Central Bank president Mario Draghi noted "tentative signs of stabilisation" in the region's economy.

The downgrades could drive up the cost of European government debt as investors demand more compensation for holding bonds deemed to be riskier than they had been. Higher borrowing costs would put more financial pressure on countries already contending with heavy debt burdens.

In Greece, negotiations on Friday to get investors to take a voluntary cut on their Greek bond holdings appeared close to collapse, raising the specter of a potentially disastrous default by the country that kicked off Europe's financial troubles more than two years ago.

The deal, known as the Private Sector Involvement, aims to reduce Greece's debt by euro100 billion by swapping private creditors' bonds with new ones with a lower value, and is a key part of a euro130 billion international bailout. Without it, the country could suffer a catastrophic default that would send shock waves through the global economy.

Prime Minister Lucas Papademos and Finance Minister Evangelos Venizelos met on Thursday and Friday with representatives of the Institute of International Finance, a global body representing the private bondholders. Finance ministry officials from the eurozone also met in Brussels on Thursday night.

At Friday's Italian auction, investors demanded an interest rate of 4.83 per cent to lend Italy three-year money, down from an average rate of 5.62 per cent in the previous auction and far lower than the 7.89 per cent in November, when the country's financial crisis was most acute.

While Italy paid a slightly higher rate for bonds maturing in 2018, which were also sold in Friday's auction, demand was between 1.2 per cent and 2.2 per cent higher than what was on offer.

The results were not as strong as those of bond auctions the previous day, when Italy raised euro12 billion and demand was strong for a sale of Spanish debt.

"Overall, it underscores that while all the auctions in the eurozone have been battle victories, the war is a long way from being resolved (either way)," said Marc Ostwald, strategist at Monument Securities. "These euro area auctions will continue to present themselves as market risk events for a very protracted period."

Italy's euro1.9 trillion in government debt and heavy borrowing needs this year have made it a focal point of the European debt crisis.

Italy has passed austerity measures and is on a structural reform course that Premier Mario Monti claims should bring down Italy's high bond yields, which he says are no longer warranted.

Analysts have said the successful recent bond auctions were at least in part the work of the ECB, which has inundated banks with cheap loans, giving them ready cash that at least some appear to be using to buy higher-yielding short-term government bonds.

Some 523 banks took euro489 billion in credit for up to three years at a current interest cost of 1 per cent.

- AP

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