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Downgrade of France's credit rating dashes uplifting week for eurozone

Unexpectedly successful bond auctions for Spain and Italy and additional lending from the European Central Bank generated speculation about a turnaround  – until S&P announced it had downgraded France.

By Staff writer / January 13, 2012



Paris

A downgrade of France’s triple-A credit rating brings not just a sour note but mild shock waves inside Europe’s financial capitals, coming at the end of a week that seemed to bode well for chances of staunching the eurozone crisis.

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The ratings agency Standard and Poor’s is preparing to drop France’s rating to double-A+, confirmed this evening by Finance Minister Francois Baroin, who said it “is not good news,” but noted that the reduced rating will match that of the US, downgraded last summer following a standoff on raising the debt ceiling. 

The downgrade raises the question of whether the eurozone can rely entirely on the German-led prescription of austerity to battle a debt crisis that turns three years old this month.

A lower rating will likely mean higher borrowing rates for France, the No. 2 economy in Europe. The rating may also decrease confidence in France’s guarantees to the European Financial Stability Fund, created in 2009, which has been used to help bail out Greece, Portugal, and Ireland and to bolster a “firewall” to stop the European debt crisis fire from spreading to the core EU countries. 

The rating also raises the hurdle for French President Nicolas Sarkozy, who is fighting an uphill battle in the polls ahead of national elections this spring.  

The downgrade was not entirely unexpected – Standard and Poor’s warned France and several other European countries at the end of last year about a potential downgrade – but its timing dashes a rare moment of optimism in Europe. 

The economic significance of the downgrade may be secondary to what it implies about faith in eurozone leadership, some say. 

"This is more a downgrade of the eurozone’s management of the crisis,” argues Sony Kapoor, of the Brussels-based economic think tank Re-Define.

“The impact of the ratings downgrade may be limited by the fact that many investors use an average of ratings and Fitch and Moody’s have maintained higher ratings on countries such as France, for now," he added.

'Tentative' hope

Spain and Italy managed to pull off robust sales of their bonds this week at surprisingly favorable terms. Italy's new leader, Prime Minister Mario Monti, has gone hammer-and-tong at his country’s debt, books, unpaid taxes, and structure. Unlike his predecessor, Silvio Berlusconi, he seems engaged and knowledgeable, which seems to have given investors confidence. 

Meanwhile, the European Central Bank gave signs of "tentative" hope for reversing the euro crisis.  Nearly $632 billion went out the side door of the ECB last month, bound for Europe’s banks.  

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