European leaders' efforts to extract the Euro Zone from the current crisis suffered a significant blow, as ratings agency Standard & Poor's followed up on its December warning by downgrading the sovereign ratings of nine European nations.

France, Europe's second largest economy, and Italy, its third largest, had their long-term ratings lowered by one and two notches respectively, with France losing its AAA status. Spain, Portugal, and Cyprus also had their ratings cut by two notches, and Austria, France, Malta, Slovakia and Slovenia by one.

Fourteen countries, including France, Spain, Finland, Ireland, and Luxembourg, had their ratings placed on negative watch, meaning that there was a 33 per cent chance the rating would be lowered again by 2013. Only Germany and Slovakia were exempt from this warning.

Bailout fund

The downgrade has significant implications for the Euro Zone, not least because it could impact the Euro 440-billion regional bailout fund, the European Financial Stability Facility, whose own AAA ratings depend on those of its contributor countries. Should it, too, experience a cut in its ratings, it would push up the costs of the EFSF.

Also clouding the region's outlook on Friday was news that talks between Greece and private creditors over the restructuring of their debt broke down, bringing the prospect of a Greek default closer. The developments broke the temporary calm that had descended in early January, with Italian and Spanish three-year bond yields falling below 5 and 4 per cent respectively in auctions on Thursday and Friday.

Too narrow a focus

Explaining the reasons for the downgrade, S&P was critical of the agreement for a new fiscal compact reached by 26 European nations on December 9, which it described as “insufficient”, both in terms of size and scope.

In addition, Europe's solution — focusing solely on austerity, rather than the external imbalances and divergences in competitiveness that existed across the region — was “self defeating”, it said.

France, which ahead of the crisis had been sharply critical of the ratings agencies, played down the significance of the latest developments. The French Finance Minister, Mr Francois Baroin, told French television the downgrade wasn't a “catastrophe”. However, Mr Olli Rehn, the EU commissioner for monetary affairs, described the downgrades as “inconsistent” and blind to the “decisive action” European nations were taking.

Related Topics