S&P hits euro zone with downgrades

France loses triple-A, Italy, Spain and Portugal cut by two notches

By William L. Watts and Christopher Noble, MarketWatch
FRANKFURT (MarketWatch) — Ratings agency Standard & Poor’s on Friday stripped France of its coveted triple-A credit rating and reduced Portugal’s debt status to junk as part of a broad reassessment of Europe’s financial soundness that highlights the severity of the euro zone’s persistent sovereign debt crisis and complicates efforts to resolve it.


Germany escaped S&P’s scrutiny unharmed. It’s triple-A credit rating was left unchanged and given a stable outlook.


S&P’s steps were certain to make it more difficult for European leaders to solve the debt crisis and could trigger a period of volatility in financial markets similar to what investors experienced in the wake of S&P’s downgrade of the United States last year, said Jeremy Hare, Managing Director of Investments at Gilford Securities. S&P’s moves would also, Hare said, shine a harsh light on the leaders’ ineffectual efforts to solve the crisis.


“It hits them right on the chin,” Hare said. “S&P is calling (German Chancellor Angela) Merkel out and saying, ‘Hey, fix the problem’.”


S&P cut France, Austria, Malta, Slovakia and Slovenia by one notch, stripping France and Austria of rare triple-A ratings that were key to their ability to support efforts to rescue struggling euro zone members. The ratings agency also downgraded by two notches Italy, Spain, Portugal and Cyprus. Portugal and Cyprus were cut to junk status.


Of the countries mentioned in Friday’s statement, only Germany and Slovakia were given stable outlooks. The rest received negative outlooks, meaning S&P believes there is at least a one-in-three chance they may be downgraded in 2012 or 2013.


S&P said it was taking the actions because Europe’s leaders had failed at recent meetings to take decisive steps to solve the region’s debt crisis. It specifically noted that a Dec. 9 summit deal did not go far enough.


“The political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those euro zone sovereigns subjected to heightened market pressures,” S&P said in a statement.


S&P went further, casting doubt on Europe’s approach of insisting on tough austerity measures as the main path to restoring financial stability in Europe.


“We believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating,” the agency said.


Instead, it highlighted “rising external imbalances and divergences in competitiveness between the euro zone’s core and the so-called ‘periphery’” as a significant source of the bloc’s problems that needed to be addressed.


The news of S&P’s action was greeted with dismay by European leaders.


“This is not good news,” French Finance Minister Francois Baroin said in an appearance on French national television. Baroin called the downgrade “a semisurprise” and added that it was “not a catastrophe.”


Baroin, who spoke after a day of swirling rumors about an imminent downgrade of France, also said that France’s economic policies would not change as a result of the downgrade.


“It is not the rating agencies who dictate French policy,” he said.


European Commission Vice President Olli Rehn said the euro zone had taken decisive action to fix the crisis.