S&P may downgrade Europe bailout fund

A rating agency's threat to downgrade 15 eurozone countries, including Germany, as well as Europe's bailout fund has added pressure on the region's leaders to find a solution to their crisis.
Workers change tube lights of the Euro sculpture in front of the European Central Bank in Frankfurt, Germany on Tuesday. (Michael Probst/Associated Press)

A rating agency's threat to downgrade 15 eurozone countries, including Germany, as well as Europe's bailout fund has added pressure on the region's leaders to find a lasting solution to their crisis at a summit this week.

Chancellor Angela Merkel on Tuesday downplayed Standard & Poor's warnings, but the possibility that a downgrade of eurozone countries could weaken the creditworthiness of Europe's bailout fund complicates the region's fight against the crisis.

Latest developments

  • A summit of leaders of the European Union that starts Friday in Brussels could decide the fate of the euro. French President Nicolas Sarkozy and German Chancellor Angela Merkel will try to persuade the rest of the EU to adopt centralized economic controls. However, there were signs Tuesday that Britain would resist the proposal. All 27 nations must approve changes to the European Union treaty, including the nine that do not use the euro as currency.
  • Greece's lawmakers overwhelmingly approved next year's austerity budget early Wednesday, extending tough spending cuts that have already left Greeks struggling as the country tries to slash its vast debts .The vote coincided with the third anniversary of a fatal police shooting of a teenager in central Athens. A commemorative march led to violence between hundreds of anarchists and riot police in the Greek capital.
  • U.S. Treasury Secretary Timothy Geithner says the U.S. Federal Reserve has no plans to give money to the International Monetary Fund to bolster the European bailout fund. Reports citing anonymous sources saying the Fed could take part in a special fund for countries trying to control their debts "are not accurate," Geitner said.

The first warning came just hours after Merkel and French President Nicolas Sarkozy urged changes to the European Union treaty that would centralize decision-making on spending and borrowing for the 17 countries that use the euro. Tighter political and economic co-ordination among euro countries is seen as a precursor to further financial aid from the European Central Bank, the International Monetary Fund, or some combination.

The threat to cut Germany's prized AAA rating was particularly surprising. Its bonds are considered among the safest in the world and are the basis upon which Europe finances its bailout fund. S&P warned in a follow-up report that it could cut the AAA rating of Europe's bailout fund by up to two notches if it decides to downgrade one of the eurozone's top-rated countries.

The bailout fund needs the AAA rating to cheaply raise money on markets. Losing it would mean it would cost billions more to fund bailouts, hurting the rescued countries that ultimately have to pay the higher interest rates.

Investors mostly took the S&P warnings in stride on Tuesday. European stocks and bonds held onto the gains they made Monday.

"What a rating agency does is the responsibility of the rating agency," Merkel told reporters in Berlin, refusing to elaborate further. However, she added she expected a meeting of European leaders in Brussels on Friday would help restore markets' confidence.

She and Sarkozy on Monday outlined sweeping plans to change the EU treaty in an effort to keep tighter checks on overspending nations. The proposal is set to form the basis of discussions at an EU summit in Brussels on Friday.

The financial markets of Italy and Spain rallied after Merkel and Sarkozy unveiled their proposals, suggesting investor are more confident Europe can survive the crisis.

Late Monday night the euro fell to $1.3330 US from $1.3460 US, unwinding much of the gains made after Merkel and Sarkozy's proposals. By Tuesday, however, it was back up to $1.3420 US — buoyed in part by a report showing a massive rebound in German industrial orders due to a double-digit increase in demand from eurozone countries.

Stock and bond markets largely overlooked S&P's threat, remaining stable on Tuesday. The bond yields for countries like Italy and Spain remained at the one-month lows they hit on Monday.

French Foreign Minister Alain Juppe said it appeared to him that S&P had made its decision before Merkel and Sarkozy released details of the new plan, so hadn't been able to factor that into its considerations.

The leaders' proposal is "exactly the response to one of the major questions from the ratings agency, which talks about insufficient European economic governance," Juppe said on RTL radio.

Sarkozy and Merkel are proposing several broad changes for the EU treaty, including the introduction of a penalty for any government that allows its deficit to exceed three per cent of gross domestic product. The penalty would be automatic — unless a majority of nations opposed it, a loophole that drew sharp criticism from analysts.

Some analysts also feel the proposal, which demands strict austerity measures, misses the mark and will only worsen much-needed growth in already feeble economies.