If the S&P rumours are true, what next for France and the eurozone?

S&P is set to confirm what the markets thought and downgrade France. Will there be a firestorm as a result?

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Yes Sarko, it's looking grim
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Simon Miller
On 13 January 2012 18:34

So here we go – ratings agency Standard & Poor’s are finally set to downgrade France tonight despite the furious, and undiplomatic, misdirection from its finance ministers towards the UK.

Along with France, Italy, Austria and Belgium are also speculated to be subject to a downgrade as S&P factors in the ongoing systemic stresses in the eurozone

But what does this mean?

If France is lucky, the bond yield rate – the cost of borrowing – will not substantially go up as we have seen with the downgrading of the US but without its own currency I cannot see how the country will convince the markets that they shouldn’t price in a higher risk factor into their spreads.

And of course there is French national pride. With President Nicolas Sarkozy already trailing to the socialists in the polls, and Le Penn snatching support on his right flank, the prospects of a successful return to power look more remote by the day. 

In addition, this causes a further headache for the eurozone and their renewed stability pact. If the socialists get in in France – and reverse a trend seen elsewhere in Europe of electing right-of-centre parties – they have promised to revisit the stability pact. 

  

What this means in practice, we do not know yet but I’m pretty sure that with the tail wind against a financial transaction tax picking up elsewhere in the eurozone, the technocrats will be reluctant to see a renegotiation of an agreement that has already seen a watering down of budgetary discipline commitments and which could see a further picking apart of the pact leading to yet another risk to the eurozone

In addition, initial estimates suggest that a downgrade will also see the European Financial Stability Facility’s lending capacity drop to €292bn (£242.9bn). Now, with Greece, Ireland and Portugal having dibs on €250bn the fund is looking weaker and weaker and will surely put more pressure on the last surviving AAA members of the eurozone, Germany and the Netherlands, to pump more cash in or to finally allow a euro-wide bond issuance as costs of borrowing jump across the region bringing more pain and costs to the embattled countries that are already up to their necks in debt. 

And then there’s poor old Greece. Reports have come in that the voluntary haircut talks have failed. As a result it looks likely that there will be a coercive default.

If it was just Greece then it should be containable but bond markets are already shifting up the yields in Italy’s borrowing rates – ironically, after the country had completed a successful three-year auction on Friday morning albeit with subdued appetite. Of course with a notice period given on rating actions, I wonder how those bond-buyers feel now?

As noted before, whence Italy there goes France and with France the whole euro-shebang could pop. In addition, the continuing problems in Hungary could knock onto Austria which is thought to have around €30bn in exposures to the troubled country.

Curiously there may not be that much movement in the equity markets as the downgrades were expected so events could already be priced-in.   

Are we in endgame? Is there something that the eurozone can pull out of its hat? Is this where the International Monetary Fund cracks heads to prevent a global contagion? The interconnections in the eurozone and indeed outside with the UK and the US could bend to breaking point in the forthcoming weeks. 

For once, it seems, Friday 13th has definitely lived up to its reputation and after months of dithering and indecisiveness, we may now finally get a measure of the leadership in Europe and whether as suspected, all their ‘actions’ were simply too little too late.

Simon Miller is the Editor of Financial Risks Today. He tweets at @simontm71 

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