Europe has been plunged into a fresh crisis after France was stripped of its coveted AAA credit rating in a mass downgrade of nine eurozone countries by the ratings agency Standard & Poor's.
S&P said austerity was driving Europe even deeper into financial crisis as it also cut Austria's triple-A rating, and relegated Portugal and Cyprus to junk status.
The humiliating loss of France's top-rated status leaves Germany as the only other major economy inside the eurozone with a AAA rating, and rekindled financial market anxiety about a possible break-up of the single currency.
S&P brought an abrupt end to the uneasy calm that has existed in the eurozone since the turn of the year by downgrading the ratings of Cyprus, Italy, Portugal and Spain by two notches. Austria, France, Malta, Slovakia and Slovenia were all cut 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". It added that fiscal austerity alone "risks becoming self-defeating".
But French finance minister François Baroin downplayed the move, saying it was "not a catastrophe".
European finance ministers tried to control the crisis by pledging to agree a new treaty to tighten fiscal rules at a summit at the end of this month.
However, the deputy prime minister, Nick Clegg, said that what Europe needed was more concerted action by all 27 EU member states rather than "more treaties". "Just dealing with the fiscal side of things which of course is absolutely essential – it is one side of the equation – must be accompanied by a more concerted effort, which I believe is best done with all 27 countries involved, to raise our productivity."
Speaking on a visit to Dublin, Clegg said: "We don't need to reach for new treaties or agreements or policies. We know what we need to do. We need to complete the single market and create a dynamic and greater growth in the EU to help us out of these problems."
Britain was not at risk of a downgrade from S&P, but Berlin sought to soften the blow to French pride when a 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."
City analysts predicted that some European banks will be downgraded in the coming week, reflecting the fact that their national governments are now seen as riskier. The French and Austrian downgrades will also reduce the firepower of the region's main bailout fund, the European Financial Stability Facility.
Mohamed El-Erian, head of the bond trading giant Pimco, predicted serious long-term consequences. He told Newsnight that the move "places a wedge in the centre of the eurozone, making a solution much more difficult".
Rumours of S&P's move had earlier sent shares falling, pushed the euro down to a 16-month low against the dollar, and forced the European Central Bank to step in to buy Italian bonds again.
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 before recovering some ground by the close.
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%.
The new technocratic government in Athens added to the gloom after talks over a second major bailout to rescue Greece'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".
This is just the start? Unfortunately, it might be. We are likely going to be subjected to more Friday afternoon credit downgrades which will wreak havoc on financial markets. I'm beginning to be convinced that rating agencies are in cahoots with large global macro hedge funds. The timing of their downgrades and the selection of countries is suspect. Very suspect indeed.
But to all those in France bemoaning this latest 'national insult', cheer up and follow my wise advice. Ignore credit rating agencies and all the excitement they generate. They are completely and utterly useless and they need to be dismantled and shut down. They have become nothing more than a political means to dictate right-wing policies throughout the developed world.
The Economist had this to say about France going soft-core:
Friday, January 13th, proved unlucky for nine euro-zone countries: they had their credit ratings cut by Standard and Poor’s (S&P) soon after the American markets closed for the week. France and Austria were stripped of their triple-A credit rating. Three smaller euro-zone countries (Malta, Slovenia and Slovakia) also suffered a one-notch downgrade. Italy and Spain had their ratings knocked down by two notches (to BBB+ and A respectively), as did Portugal and Cyprus, whose debts are now considered junk by S&P.
Though grim, the news was not the blanket downgrade feared by eurocrats. In December S&P had given a warning of a possible downgrade to all euro-zone countries, bar Greece (which could fall no further) and Cyprus (which was already on the hit-list)—just days before leaders of the European Union met in Brussels to tackle the euro-zone crisis once and for all. S&P argues that their fire-fighting efforts have fallen short of what is needed, hence the downgrades. The December summit had "not produced a breakthrough of sufficient size and scope to fully address the euro zone’s financial problems,” the ratings agency said in a statement.
According to S&P, EU leaders have misdiagnosed the euro-zone crisis. They have focused too much on tackling the increase in governments’ budget deficits, which is only part of the problem. As a result, they did not pay enough attention to the deeper causes of the crisis: the divergence in competitiveness between the euro-zone’s core of strong economies and its struggling "periphery" as well as the huge cross-border debts that stem from this gap. Reforms based solely on fiscal austerity could easily become self-defeating, notes S&P.
Although the summit's failures are shared, not all members of the euro zone have to bear the penalties in terms of lower credit ratings. Ireland has retained its investment-grade of BBB+. The ratings on Belgium and Estonia were also left alone. And crucially, S&P reaffirmed the triple-A credit ratings of Germany, the Netherlands, Finland and Luxembourg. There is no small irony here. Having identified the euro’s internal imbalances as the main issue, S&P’s own ratings favour the euro zone’s saving gluttons who are part of the problem. These countries have persistently run current-account surpluses, and a surplus is an imbalance, after all. It seems that mercantilism has paid off—except in the case of Austria, whose economy is judged too close for comfort to trouble spots, such as Italy and Hungary.
France is neither thrifty nor competitive enough to be lumped in with the saving gluttons. Its downgrade was widely expected and in principle should already be factored in by forward-looking bond markets. Indeed the price of US Treasury bonds even rose (ie, yields fell) when S&P withdrew America’s triple-A credit rating in August. French politicians are playing down the significance of the changes. "It is not good news…but it is not a catastrophe," was the response of the country’s finance minister, François Baroin. S&P itself suggested that the downgrade was not the end of the world. Only three euro-zone countries are rated junk, it said. The rest are still investment grade and therefore very unlikely to default.
Yet so fragile is confidence in markets for euro-zone bonds that investors are unlikely to greet the ratings downgrade with a Gallic shrug. In the case of France, it is not only a blow to the country's prestige. It also tears a hole in the already threadbare euro-zone safety net, the European Financial Stability Fund. That is now backed by only four AAA-rated countries, which account for less than half of euro-zone GDP. The faith in euro-zone bonds is bound to be unsettled.
The S&P decision, however, may not even be the biggest source of anxiety. Talks between Greece and its private-sector creditors on the losses these should bear broke down on Friday afternoon. This failure raises the spectre of a messy Greek default. In such circumstances, investors might take a hint from the revised S&P ratings. If things go horribly wrong, Germany is now the only big euro-area bond market in which investors’ money might be considered truly safe.
A messy Greek default? Is that the next shoe to drop in this European saga? I doubt it. Although it looks like Greece is on a CAC warpath, I think cooler heads will prevail. Europe is not going under and my bet is that elite hedge funds are going long euros at this level and they will end up profiting from this mess.
Below, Euronews reports on mass downgrade of credit ratings across the eurozone has brought left-leaning protesters out onto the streets of Paris. I think they should ignore all the fuss. S&P will bring no more shame to France than Inspector Clouseau (lol).