European leaders will this week try to rescue under-fire efforts to deliver new fiscal rules and cut Greece’s debt burden as investors ignore Standard & Poor’s euro- region downgrades.
Greek officials will reconvene with creditors on Jan. 18 after discussions stalled last week and governments elsewhere are preparing for a Jan. 30 summit as the European Central Bank warns against “watering down” a revamp of budget laws. French borrowing costs fell today as the government in Paris sold 8.59 billion euros ($10.9 billion) in debt.
The talks on Greece and budgets may serve as tougher tests of the tentative recovery in investor sentiment than S&P’s decision to cut the ratings of nine euro-region nations, including France. History suggests fallout from the downgrades may be limited. JPMorgan Chase & Co research shows that 10-year yields for the nine sovereigns that lost their AAA status between 1998 and last year’s U.S. downgrade rose an average of two basis points the next week.
Efforts to toughen budget laws and make Greek debt more sustainable “deserve far more attention than these rating changes, which as usual are lagging fundamental developments,” Joachim Fels, chief global economist at Morgan Stanley in London, said in a note to clients yesterday.
Investors shrugged off the S&P downgrade as France sold 1.895 billion euros of one-year notes at a yield of 0.406 percent, down from 0.454 percent on Jan. 9.
The euro pared declines against the dollar after the ECB was said to buy Italian and Spanish debt, trading at $1.2671.
Policy makers fanned out over the weekend to seize back the initiative. German Chancellor Angela Merkel said S&P’s decision and criticism of “insufficient” policy steps reinforced her view that leaders must redouble efforts to resolve the two-year crisis. Germany is now alone in the euro area with a stable AAA.
Reacting to Spain’s downgrade to A from AA-, Prime Minister Mariano Rajoy pledged spending cuts and a banking-system cleanup, as well as a “clear, firm and forceful” commitment to the euro’s future. French Finance Minister Francois Baroin said the reduction of France’s rating was “disappointing,” yet expected, and markets were “muted” in response.
Investors ignored S&P last August when it cut the U.S. to AA+, pushing the yield on the benchmark U.S. government bond to a record of 1.6714 percent seven weeks later. One difference is that the U.S., unlike France, is prepared and able to print money, making it easier for the world’s largest economy to pay its debts.
“The U.S. is still rightly seen as a safe haven,” Fredrik Erixon, director of the European Centre for International Political Economy in Brussels, said. “The U.S. is a big liquid economy with a strong tradition of honoring its debts in modern times and a central bank pledged to taking action if needed. It’s different with France in the sense that they cannot rely on strong central bank policies.”
Speaking over the weekend at a meeting of her party, Merkel played down the risk that weaker French creditworthiness saps potency from Europe’s 440 billion-euro bailout fund. The European Financial Stability Facility, which is designed to fund rescue packages for Greece, Ireland and Portugal partially with bond sales, owes its AAA rating to guarantees from its sponsoring nations.
Don’t Need AAA
“I was never of the opinion that the EFSF necessarily has to be AAA,” Merkel told reporters in the northern German city of Kiel.
Luxembourg Prime Minister Jean-Claude Juncker said the EFSF’s shareholders will explore ways to maintain the top rating of the fund, which is scheduled to sell up to 1.5 billion euros in 6-month bills this week. In the meantime, Merkel and other European leaders have pledged to move quickly toward setting up its permanent successor, the European Stability Mechanism, this year -- one year ahead of the original plan.
In an interview with Bloomberg Television today in Hong Kong, U.K. Chancellor of the Exchequer George Osborne said he sees some reason for optimism in Europe, while acknowledging that 2012 is set to be a challenging year.
“Obviously people are anxious about the year ahead, and I understand that, but I would say there are some grounds for optimism,” Osborne said, citing recent liquidity measures by the ECB.
Merkel had been scheduled to meet with French President Nicolas Sarkozy and Italian Prime Minister Mario Monti in Rome on Jan. 20 to flesh out details of crisis-rescue efforts before a European summit 10 days later. The leaders will likely delay those talks until after the summit, an Italian government official said.
The leaders are in discussions as the ECB warns governments against diluting a December pact to toughen budget rules designed to avoid a repeat of the crisis.
Recent changes in a text aimed at translating the agreement into an international treaty “imply a substantial watering down” and “run against the spirit” of the original plan, ECB Executive Board member Joerg Asmussen said in a letter last week. Leaders have said they may complete the rulebook by Jan. 30, a month earlier than scheduled.
A more immediate threat may come from Greece, where investors have warned of a collapse of the financial system. Failure to strike a deal with creditors could imperil the ability of the government in Athens to pay back 14.5 billion euros maturing March 20 and force it to seek even more aid from governments.
“A Greek default would have a major impact on the euro as it would spread contagion to other bond markets in the euro zone,” Mansoor Mohi-uddin, Singapore-based head of foreign exchange strategy at UBS AG, said in a Jan. 14 note.
Greece’s creditor banks broke off talks three days ago after failing to agree with the government on how much money investors will lose by swapping their bonds. Proposals by a committee representing financial firms haven’t produced a “constructive consolidated response by all parties,” the Washington-based Institute of International Finance said in a statement yesterday. Talks between Prime Minister Lucas Papademos, Finance Minister Evangelos Venizelos and Charles Dallara, the managing director of the IIF, will resume Jan. 18.
Greek officials and the nation’s creditors agreed in October to implement a 50 percent cut in the face value of Greek debt, with a goal of reducing Greece’s borrowings to 120 percent of gross domestic product by 2020.
2012 began with speculation the worst may be over as borrowing costs fell, evidence of economic resilience emerged and the ECB said it had quelled a credit crunch at banks. Now the crisis threatens to reignite.
“While the market impact of the downgrades is unlikely to be very significant in the short-term, they serve as a stark reminder that the euro area sovereign debt crisis is here to stay,” said Royal Bank of Scotland Group Plc economists led by Jacques Cailloux. “We continue to expect the crisis to deepen.”