Analysts: S&P downgrades could have been worse

[January 14, 2012]  WASHINGTON (AP) -- The decision by Standard & Poor's to strip France of its prized AAA credit rating and downgrade eight other European countries slammed a continent struggling with a debt crisis and an economic slowdown.

But beleaguered Europeans can take some comfort: It could have been worse.

Investors had plenty of time to brace for the bad news. S&P put 15 countries, including Germany and France, on notice last month that they faced potential downgrades. The advance notice means the downgrades likely won't panic financial markets and drive up European governments' borrowing costs much higher than they already are.

"People knew it was coming, and it was only one rating agency," said Marc Chandler, head of global currency strategy at Brown Brothers Harriman. Moody's and Fitch Ratings have yet to follow S&P.

Stocks fell Friday as downgrade rumors reached the trading floors of Europe and the United States. But the declines were nothing like the wrenching swings of last summer and fall, when the debt crisis threw the markets into turmoil.

When the news came Friday, it wasn't as harsh as it might have been. S&P had threatened last month to knock France's credit rating down two notches. Instead, it settled for one, demoting France to AA+, just where it put the U.S. credit rating in an August downgrade.

S&P spared Europe's mightiest economy the indignity of a downgrade, leaving Germany with its AAA rating intact.

Austria lost its AAA status, while Italy and Spain fell by two notches and Portugal's debt was consigned to junk. S&P also cut ratings on Malta, Cyprus, Slovakia and Slovenia.

Analysts note that S&P's decision to downgrade long-term U.S. government debt in August did nothing to stop investors from continuing to buy U.S. Treasurys, though it did temporarily shake the U.S. stock market.

The downgrades in Europe are "going to create bad headlines for a day or two," said Jacob Funk Kirkegaard, research fellow at the Peterson Institute for International Economics. But "there's no underlying new information ... This will be quickly forgotten."

The Dow Jones industrial average declined 0.5 percent Friday, while stocks sank 0.1 percent in France and 0.6 percent in Germany.

European countries, which borrowed heavily before the Great Recession, have struggled with high government debts after the weak economy depleted tax revenues and drove up spending on unemployment benefits and other social programs. Greece, Portugal and Ireland have already required bailouts.

And bigger countries like Italy and Spain are under financial pressure, partly because nervous investors are demanding higher interest rates to purchase their bonds.

The downgrade of France could have consequences. It will put pressure on the fund that Europe uses to bail out the weakest countries that use the euro. The fund, after all, is only as strong as the countries that contribute to it, and France is the second-biggest contributor after Germany. The bailout fund may have to pay higher interest rates to borrow -- and may have to charge higher rates to countries like Ireland that rely on it.

For now, the fund still has a rating of AAA. That means that it can borrow on the bond market at low rates.

The rating agency's verdict could also shake up French politics. If the loss of its top-notch credit rating means France has to pay higher interest rates, the government will find it harder to cut its budget deficit.

President Nicolas Sarkozy has staked his credibility -- and his re-election hopes -- on meeting a series of deficit-reduction targets and balancing France's budget by 2016. In order to stay on track, his government was forced twice last year to make extra cuts.

French Finance Minister Francois Baroin said the downgrade was "bad news" but not "a catastrophe."

"You have to be relative, you have to keep your cool," he said on France-2 television. "It's necessary not to frighten the French people about it."

Fred Cannon, chief equity strategist at Keefe, Bruyette & Woods, shrugged off the news. "A lot of folks have not thought France was a AAA country for a long time," he said.

France hasn't balanced a budget in three decades, and its deficit hit 7.1 percent of its gross domestic product last year -- more than twice the legal limit of 3 percent for the 17 nations that use the euro. It also is paying a significant amount to help bail out other troubled eurozone members such as Greece, Portugal and Ireland.

Since S&P issued its downgrade threat in December, new European governments have taken "substantive actions" to bring debts under control, noted Jeff Kleintop, chief market strategist for LPL Financial.

Budget cuts in Italy and Spain have made investors more willing to buy their government bonds, pushing down the interest rates they have to pay.

Earlier Friday, Italy had capped a strong week for government bond auctions. Its borrowing costs dropped for the second straight day as it successfully raised as much as euro4.75 billion ($6.05 billion). Spain and Italy completed successful bond auctions on Thursday.

Italy's euro1.9 trillion in government debt and heavy borrowing needs this year have made it a focal point of the European debt crisis. Italy has passed austerity measures and is on a structural reform course that Premier Mario Monti claims should bring down Italy's high bond yields, which he says are no longer warranted.

The European Central Bank has relieved some of the pressure, too. It has provided banks with euro489 billion in cheap loans, some of which they have used to buy government bonds.

ECB President Mario Draghi noted "tentative signs of stabilization" in Europe.

Chandler at Brown Brothers Harriman warns that Europe still faces big problems. Italy and Spain together must refinance hundreds of billions of euros in debt this year. And the European economy is almost certain to slip into recession, if it hasn't already. A deteriorating economy across the continent could worsen the debt crisis by reducing tax collections and driving up social spending.

Europe's troubles are already having an impact in the United States. The Commerce Department reported Friday that exports to Europe fell 6 percent in November.

[Associated Press; By PAUL WISEMAN]

AP Business Writer Greg Keller in Paris contributed to this report.

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