EU Revamp Pushed as S&P Issues Warning

By Patrick Donahue and Helene Fouquet - Dec 6, 2011 11:04 AM GMT+0700
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Downgrades of Germany and France would affect the rating of the European Financial Stability Facility, the bailout fund for struggling euro member countries that has funded rescue packages for Greece, Ireland and Portugal partially through bond sales. Photographer: Jacques Demarthon/AFP/Getty Images

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Dec. 6 (Bloomberg) -- Barbara Ridpath, chief executive officer of the International Centre for Financial Regulation, talks about Standard & Poor's review of 15 euro nations' credit ratings, Europe's debt crisis and the outlook for the global banking industry. Ridpath speaks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)

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Dec. 6 (Bloomberg) -- Phillip Swagel, a professor of economics at the University of Maryland’s School of Public Policy who was an assistant U.S. Treasury secretary for economic policy in the George W. Bush administration, talks about Europe's sovereign debt crisis. Standard & Poor’s said Germany and France may be stripped of their AAA credit ratings as the debt crisis prompts 15 euro nations to be put on review for possible downgrade. Swagel speaks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)

German Chancellor Angela Merkel and French President Nicolas Sarkozy strengthened their push for new rules to tighten euro area economic cooperation after Standard & Poor’s said it may downgrade credit ratings across the region.

The leaders of Europe’s two biggest economies responded in a joint statement late yesterday that they “took note” of the move by S&P, while both countries “reinforce their conviction” that common proposals for closer fiscal union in the European Union will “strengthen coordination of budget and economic policy,” and promote stability and growth.

“The actions of the last three years have shown that the euro zone governments are not prepared to act collectively in a way that convinces markets,” said Paul Donovan, deputy head of global economics at UBS AG in London. The S&P move “may perhaps heighten the desirability of coming out with a compelling solution for the French and the Germans.”

Germany and France risk losing their AAA credit ratings in a review of 15 euro nations for possible downgrade, S&P said. At an earlier meeting in Paris, Merkel and Sarkozy said both countries were aligned on backing automatic penalties for deficit violators and locking limits on debt into euro states’ constitutions. Investors say such moves might pave the way for the European Central Bank to do more to fight the debt crisis.

ECB Focus

The question is whether the Franco-German push toward integration is enough to prompt ECB President Mario Draghi to step up the central bank’s response, said Carsten Brzeski, an economist at ING Group in Brussels.

While the leaders’ announcement is “a good start to the week of truth,” Merkel and Sarkozy still “need to put money where their mouth is and bring everyone else on board,” Brzeski said by phone. “From a financial market perspective, it’s about them doing enough to deliver Draghi’s fiscal compact.”

The euro fell for a third day after S&P’s announcement, which put European nations including the six AAA-rated countries on watch for potential downgrades pending the outcome of a Dec. 8-9 leaders summit. The 17-nation currency declined 0.3 percent to $1.3367 at 12:47 p.m. in Tokyo. Asia stocks (MXAP) dropped for the first time in seven days.

‘Excessive’

The S&P move was “excessive,” said Vincent Truglia, managing director at New York-based Granite Springs Asset Management LLP and a former head of the sovereign risk unit at Moody’s Investors Service, a rival rating company.

“Countries like Germany, Luxembourg, Netherlands, Finland are AAA, and Austria is a pretty strong AAA,” he said.

S&P said that ratings could be cut by one level for Austria, Belgium, Finland, Germany, Netherlands and Luxembourg, and by up to two notches for the other governments.

The other countries warned are Estonia, France, Ireland, Italy, Malta, Portugal, Slovakia, Slovenia and Spain, according to S&P. The company said it maintained the negative outlook for Cyprus, and Greece wasn’t put on “creditwatch.”

“The credit opinion is based on factors that can’t be influenced by Austria alone,” according to a statement from Austria’s finance ministry. “It is important that the summit later this week comes up with concrete results.”

With the fate of the currency shared by the 17 euro states at risk, Merkel and Sarkozy are stressing their common platform going into the summit that aims to end the crisis now in its third year.

‘United’ Resolve

“Germany and France are united in their resolve to take all necessary measures together with their European partners and the European institutions to safeguard the stability of the euro zone,” according to their statement e-mailed late yesterday after the S&P announcement.

Among the measures announced were plans to fast-track the euro’s permanent rescue fund to 2012, one year earlier than envisaged. Germany and France will also seek to ensure that decisions by the fund, the European Stability Mechanism, can be made by a “qualified majority” rather than a unanimous vote by the participating governments. Sarkozy said they aimed to reach consensus on treaty change with other euro leaders by March.

“We don’t have time -- we are conscious of the gravity of the situation,” Sarkozy said after meeting with Merkel over lunch at the Elysee palace. “We want to go as fast as possible based on this agreement between France and Germany, which is open to others.”

Response

Safeguarding banks, limiting the damage to Italy and Spain and finding additional rescue funds may hinge on the response to Franco-German demands for closer economic integration and tougher policing of fiscal rules.

Draghi signaled last week that should a “new fiscal compact” emerge among the euro nations, “other elements might follow.” Merkel and Sarkozy both declined to comment on Draghi’s comments, stressing the ECB’s independence.

“It’s a step in the right direction for the ECB but we’ll want to know how the automatic sanctions are triggered,” said Klaus Baader, co-chief economist at Societe Generale SA. “When France and Germany have joint press conferences and say we agree on everything you have to take that with a pinch of salt.”

With the EU summit looming, U.S. Treasury Secretary Timothy Geithner arrives in Frankfurt to meet with Draghi and Bundesbank President Jens Weidmann before heading to Berlin for talks with German Finance Minister Wolfgang Schaeuble. The ECB holds a policy meeting on Dec. 8.

‘Bit of Trust’

European leaders will seek to “win back a bit of trust” at the summit after “our reliability has suffered,” Merkel said in Paris. “We are steadfastly determined to make the decision at the council now.”

Merkel and Sarkozy yesterday repeated their rejection of jointly sold euro bonds in solving the crisis, while seeking to calm concerns of euro-area member states that the European Court of Justice would be able to veto national budgets as part of their proposal for centralized deficit supervision.

With euro bonds ruled out, “the onus is still on the ECB to print money to make huge loans or bond purchases and draw a line under the crisis,” said Jennifer McKeown, senior European economist at Capital Economics in London.

The move by S&P adds impetus to that, said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London.

“Anything which impacts the perceived creditworthiness of the main guarantors of euro zone debt is bad news for planned steps towards a fiscal union,” he said in an e-mail. “All this puts more pressure on the ECB to hold the fort.”

To contact the reporters on this story: Patrick Donahue in Berlin at pdonahue1@bloomberg.net; Helene Fouquet in Paris at hfouquet1@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net