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On Friday the 13th, ratings agency Standard & Poor’s (S&P) downgraded the credit status of nine European nations. The ratings of Cyprus, Italy, Portugal and Spain were lowered by two notches while Austria, France, Malta, Slovakia and Slovenia were lowered by one. Italy’s rate cut from A to BBB+ reflects the second S&P downgrade since September 19th, and Portugal’s debt has now reached “junk” status. “Today’s rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policy makers in recent weeks may be insufficient to fully address ongoing systemic stresses in the euro zone,” said S&P in a written statement.
The downgrade was hardly a surprise. On December 5th, S&P put 15 European nations on review, warning them that the decisions made during the European Union (EU) summit ending on December 9th would be the primary basis for determining those nations’ credit ratings going forward. The result of that meeting, the EU’s fifth attempt to stem its credit crisis, produced a “deal” best described as an agreement to come to an agreement. The only real highlight of the summit was English Prime Minister David Cameron’s rejection of the treaty in favor of a concept increasingly out of favor among other EU leaders: national sovereignty.
Despite the warning by S&P, the downgrade is being characterized as a “rebuke” of the EU’s prime movers, French president Nicolas Sarkozy, and German Chancellor Angela Merkel. Both are on politically shaky ground. Sarkozy is running for re-election in the spring and the downgrade of France to AA+ for the first time since 1975 does not bode well for a man who had often cited his country’s AAA rating as a “badge of honor.” In Germany, one of Merkel’s partners in her governing center-right coalition, the Free Democrats Party (FDP), is sliding deeper into crisis, threatening her grip on power as well.
Germany was the only EU nation to emerge from this latest downgrade completely unscathed. It retained both its AAA rating and a stable outlook going forward. 14 other EU countries–Austria, Belgium, Cyprus, Estonia, Finland, France, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia, and Spain–were put on a “negative” outlook. This means the S&P believes that there is a better than one-in-three chance a country’s rating will be lowered in 2012 or 2013. “It will make it harder to erect firewalls around struggling euro zone economies and convince investors that things are more sustainable,” said Simon Tilford, chief economist for the Center for European Reform in London.
Two countries to watch in that regard are Italy and Spain. Both began the year with fairly successful debt sales, but after Friday’s downgrade both countries saw their bond yields rise, along with those of France and Belgium, while safe-haven German Bund futures hit a new high of 140.22, up over a full point for the day. Another possible complication arising from the downgrade is the likelihood that the European Financial Stability Fund (EFSF) will also lose its AAA rating as well, because its guarantor nations have had their ratings cut. An EFSF downgrade could be avoided if the four remaining AAA nations–Germany, the Netherlands, Finland, and Luxembourg–would increase the size of their guarantees, but such a move is not considered likely.
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