S&P warns of euro zone credit rating downgrade

Standard & Poor's warns it could carry out broad downgrade if EU leaders fail to agree on debt crisis solution this week.

Standard and Poor's 311 R (photo credit: REUTERS/Brendan McDermid)
Standard and Poor's 311 R
(photo credit: REUTERS/Brendan McDermid)
NEW YORK - Standard & Poor's on Monday warned it may carry out an unprecedented mass downgrade on the credit ratings of euro zone countries if EU leaders fail to reach an agreement on how to solve the region's debt crisis in a summit later this week.
S&P placed the ratings of 15 euro zone countries on credit watch negative - including those of top-rated Germany and France, the region's two biggest economies - and said "systemic stresses" are building up as credit conditions tighten in the 17-nation region.
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While a credit watch negative typically signals a possible downgrade in no more than three months, S&P said it expects to conclude its review "as soon as possible" following a crucial summit of EU leaders on Friday.
Investors hope to see a comprehensive crisis response from policy makers, including the European Central Bank, at the EU summit.
"Systemic stresses in the euro zone have risen in recent weeks to the extent that they now put downward pressure on the credit standing of the euro zone as a whole," S&P said in a statement.
The higher interest rates that euro governments have been forced to pay to sell sovereign debt as a result of greater perceptions of risk and a rising chance of economic recession in the region next year are also weighing on the ratings, S&P said.
If a downgrade does materialize, countries such as Germany, Austria, Belgium, Finland, the Netherlands and Luxembourg would likely see ratings cuts of only one notch. The other nine countries could suffer downgrades of up to two notches, S&P said.
Of the other two members of the euro zone, S&P already has Cyprus on credit watch negative, while Greece is rated CC, which already denotes high possibility of default in the near term.
EU leaders respond to S&P warning, promise action
French President Nicolas Sarkozy and German Chancellor Angela Merkel responded to the S&P warning by saying they were united in their determination to do everything necessary to secure the stability of the euro zone.
However, France's finance minister, Francois Baroin, ruled out a new round of austerity measures, and said S&P's move had not taken into account a Franco-German plan to handle the crisis.
S&P's warning on Germany, whose sovereign debt is considered a European safe-haven, caught some investors off guard, although a weak sale of German benchmark bonds in late November had sparked fears of a spread of the debt crisis.
"Germany might be a bit of a surprise because it has a sterling credit rating. But one things Germany is worried about is whether, if they share the financial burdens of some of their financial partners, their own credit standing will suffer," said Cary Leahey, senior economist at Decision Economics in New York.
Other investors saw S&P's warning on the euro zone consistent with its decision to strip the United States from its AAA rating in August.
"It would bring the top six (euro zone countries) in line with the United States," said Dan Fuss, vice chairman of Loomis Sayles, which has more than $160 billion in assets under management. "When you look at the underlying factors here, are these really better credits than the US? No. Not by a long shot."
S&P said its analysis will focus on the political dynamics - in specific countries and in the euro zone as a whole - that "appear to be limiting the effectiveness of efforts to resolve the market confidence crisis."
With many investors demanding a larger role for the European Central Bank in the solution of the crisis, S&P will also review the ECB's monetary flexibility "to address the economic and financial stresses the countries in the euro zone are increasingly facing."
Markets cool following S&P warning
News of S&P's move had leaked to the press in the afternoon, causing US stocks to trim gains. US stock index futures slipped further after the announcement, which was made after US markets closed.
The euro, which had already erased gains against the dollar after news of the S&P warning had leaked, slipped further after the announcement.
But hopes that EU leaders will come up with a comprehensive plan to tackle the crisis still supported market sentiment.
"The market is very quiet even after the S&P news," said Mogens Hauschildt, regional director at Western Union Business Solutions in Vancouver, British Columbia. "That's because they are set for the ECB and the EU meeting on Friday."
The other two major ratings agencies, Moody's and Fitch, have already said they could soon review the rating of core euro zone countries, but they still maintain a stable outlook on top-rated euro zone countries.