S&P poised to swing ratings ax in Europe, sources say

Germany will keep its AAA rating at Standard & Poor’s as France and Austria face downgrades on concern about Europe’s sovereign debt crisis, according to government officials and people familiar with the matter.
France will lose its AAA rating for the first time, Agence France-Presse reported, citing an unidentified government official. Italy and top-rated Austria will also be downgraded, according to two people familiar with the situation. The European official said the announcement may come at 9 p.m. Brussels time.
“If Germany stays AAA, that is about the best outcome possible from this starting point,” said Gary Jenkins, the director of independent firm Swordfish Research in London.
A confirmation of Germany’s AAA rating may lessen the blow of a French downgrade as governments struggle to convince investors that they can cut deficits and end the turmoil that has roiled markets for two years. Still, France and Austria losing their top ranking may erode the firepower of the euro- region’s bailout fund that’s needed to tap markets to finance aid for Greece, Ireland and Portugal.
The yield on France’s 10-year government bond rose 4 basis points to 3.08 percent, while the German 10-year yield slipped 7 basis points to 1.77 percent. The euro declined to a 16-month low against the dollar, falling as much as 1.5 percent to $1.2624.
Rescue Fund
A French downgrade would threaten the potency of the region’s main bailout fund, which currently has 440 billion euros ($558 billion) in firepower. 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.
“It will be interesting to see what the strategy will be regarding the EFSF, if France and Austria’s ratings were both lowered, it would limit the volume of AAA rated EFSF paper that could be issued, or the EFSF could begin to issue non triple-A rated paper,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London
S&P first placed the ratings of 15 euro nations, including Germany and France, on review for possible downgrade before a Dec. 9 European Union summit, where leaders made their fifth attempt to come up with a comprehensive solution to end the debt crisis. At the meeting they agreed to forge a tighter fiscal union, shore up the region’s bailout funds and tighten rules to curb future debts.
Moody’s, Fitch
Moody’s Investors Service followed on Dec. 12, saying it would review the ratings of all EU countries after the summit failed to produce “decisive policy measures” to end the region’s debt turmoil. Fitch Ratings is also considering cuts to euro-region nations rated below AAA.
“The crisis remains unresolved and policy action has still not been sufficient to contain it,” said Nick Kounis, head of macro research at ABN Amro Bank NV. “We’ve had a few calmer weeks with sentiment improving, but the situation was vulnerable to re-escalation and the rating downgrades are a potential trigger for a re-escalation given not enough has been done on the policy front to contain the crisis on a sustainable basis.”
The euro group of finance ministers will issue a statement on S&P tonight, a European official said on condition of anonymity because the announcement has yet to be made.
Looming Recession
The downgrade comes amid signs that France is slipping into a recession, and may further complicate French President Nicolas Sarkozy’s bid for re-election in voting in April and May. Sarkozy, who has sought to protect his government’s creditworthiness by announcing tax increases and spending cuts, has attempted to position himself as the most credible candidate on economic matters.
Sarkozy trails his main rival, Socialist Party candidate Francois Hollande, by about 14 points in voting intentions for the second round of the election, according to a BVA poll for Le Parisien newspaper published Jan. 9.
Sarkozy has tried to minimize the potential impact of a downgrade. “If rating companies pull it, we’ll face the situation coolly and calmly,” he said in an interview with newspaper Le Monde on Dec. 12. “It would be an additional difficulty but it’s not insurmountable. What is important is the credibility of our economic policy and our strategy of reducing spending.”
Sarkozy’s spokesman, Franck Louvrier, declined to comment on reports today that the government has been notified by S&P of a cut in the country’s rating.
Italy, Spain
Italy’s credit rating will be cut two levels by S&P, according to an EU official who declined to be identified because the decision is not yet public. S&P also cut Spain, French newspaper Les Echos reported. The decisions may complicate gains in recent days in bringing down borrowing costs. The two countries sold 26.75 billion euros of debt in the past two days and yields plunged at their first auctions of the year.
Still, Italy (.IT10) faces more than 50 billion euros of bond maturities in the first quarter and accounts for about a third of the 1.2 trillion euros that euro-area governments must raise this year to finance debt.
“Losing AAA status may mean some investors can’t buy debt from France, the EFSF, and the European Investment Bank, but this is quite a small subset now,” said Roger Francis, an analyst at Mizuho Securities in London.
A comparable lack of impact was experienced in the U.S. bond market after S&P stripped the country of its AAA rating for the first time on Aug. 5, citing the nation’s political process and a failure by lawmakers to cut spending or raise revenue enough to reduce a record budget deficit. The yield on the benchmark U.S. government bond fell to a record 1.6714 on Sept. 23.
–Bloomberg News–