Eurozone in new crisis as credit agency downgrades nine countries

S&P action leads to fall in euro and share prices while European Central Bank forced to buy Italian bonds

guardian.co.uk, Larry Elliott and Phillip Inman, Friday 13 January 2012

France’s loss of its top-rated status leaves Germany as the only other major
 economy inside the eurozone with a AAA credit rating.
Photograph: Scott E Barbour/Getty Images

Europe has been plunged into a fresh crisis after France admitted it had been stripped of its coveted AAA rating in a mass downgrade of nine eurozone countries by the credit ratings agency S&P.

The agency downgraded the ratings of Cyprus, Italy, Portugal and Spain by two notches. It also lowered Austria, France, Malta, Slovakia and Slovenia by one notch.

The agency said that its actions on eurozone ratings were "primarily driven by insufficient policy measures by EU leaders to fully address systemic stresses".

Ahead of the announcement share prices plunged, the euro dropped to a 16-month low against the dollar and the European Central Bank was forced to step in to buy Italian bonds after European sources admitted action by the credit ratings agencies was imminent.

Bringing an abrupt end to the uneasy calm that has existed in the eurozone since the turn of the year, the heavily-trailed S&P move rekindled financial market anxiety about a Greek default and possible break-up of the single currency.

Nicolas Sarkozy was due to go on national TV to explain the humiliating loss of France's top-rated status, leaving Germany as the only other major economy inside the eurozone with a AAA rating. French finance minister François Baroin downplayed the move, saying it was "not a catastrophe".

The moves followed a warning from S&P last month that it was looking hard at the credit ratings of 15 of the eurozone's 17 members. Germany and the Netherlands were quick to make it clear they were not on the list of targeted countries circulated by S&P to European capitals ahead of an announcement that was expected to be made after the close of business on Wall Street. Investors piled into safe haven assets such as the dollar, while the UK was rewarded with even lower borrowing costs as 10-year bonds slipped below 2%.

Britain is not at imminent risk of a downgrade, but Berlin sought to soften the blow to French pride when a senior German politician close to Angela Merkel said the UK should have been first in line for a cut in its AAA status on the grounds that its collective private and public sector debts are the largest in Europe.

Michael Fuchs, deputy leader of the Christian Democrats, said: "This step is out of order. Standard and Poor's must stop playing politics. Why doesn't it act on the highly indebted United States or highly indebted Britain?"

He added: "If the agency downgrades France, it should also downgrade Britain in order to be consistent."

The FTSE 100 dropped 100 points before recovering late in the day to finish down 26 points at 5636 while the Dow Jones in New York fell 120 points to 12350 by afternoon trading.

S&P was expected to blame the escalating costs of supporting indebted euro nations for the downgrade. The vulnerability of banks in the currency club to bad loans in Greece, Portugal and Ireland is also believed to be a key reason for the downgrades.

The new technocratic government in Athens added to the gloom after talks over a second major bailout to rescue the country's finances broke up without an agreement. Officials from the International Monetary Fund, the European Union and the ECB arrive in Athens on Tuesday for talks on a new €130bn bailout package, which will be impossible unless Greece first strikes a deal with the banks, insurance companies and hedge funds that have lent it money.

The Greek government said talks with its creditors would resume on Wednesday, but analysts voiced concerns that hedge funds were blocking a deal that involves them writing off 50% of their loans.

Germany considers Greece to be the main faultline in the euro crisis and is urgently seeking a resolution to talks over a deal, but has insisted Brussels holds out for a private sector deal. Officials hinted on Friday night that Greece could default on 100% of its loans if the private sector refuses to come back to the negotiating table and accept a voluntary agreement.

A spokesman for the troika said: "We very much hope, however, that Greece, with the support of the euro area, will be in a position to re-engage constructively with the private sector with a view to finalising a mutually acceptable agreement on a voluntary debt exchange consistent with the October 26/27 agreement, in the best interest of both Greece and the euro area."

Unprecedented action by the European Central Bank in recent weeks had reassured many investors that policymakers were getting on top of the crisis. The ECB has lent more than €400bn to eurozone banks to bolster their reserves and prevent a repeat of the 2008 credit crunch.

But the S&P downgrades are likely to undermine these efforts and make foreign banks wary of lending to their counterparts in Europe.

Graham Neilson, chief investment strategist at Cairn Capital, warned: "This is just the start. There will be more to come and not just in Europe – there is simply still too much debt and not enough growth in developed economies."

France has already shown its anger at the prospect of a downgrade. Central Bank chief Christian Noyer raised eyebrows in London before Christmas when he said Britain "has more deficits, as much debt, more inflation, less growth than us".

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