It was bad news for France, but probably worse news for France’s neighbors: Late on Nov. 19, Moody’s Investors Service (MCO)stripped Paris of its AAA bond rating. The move, though widely anticipated, raises the likelihood that other core European economies could be hit with downgrades.
The Moody’s downgrade followed a similar action by Standard & Poor’s (MHP) last January, and market response on Nov. 20 was relatively muted: Yields on French 10-year debt widened to 2.134 percent, which was the biggest increase in a month but still close to a record low 2.002 percent reached on Aug. 3. The euro fell in early trading against other currencies after the announcement, to $1.28.
More ominously for Europe, Moody’s reiterated its “negative outlooks” on the ratings of Germany, Netherlands, and Austria. Those countries are at risk of downgrade, Moody’s said, because they bear “the main financial burden of support” for the mechanisms put in place to aid the region’s weaker economies.
The downgrade underscores “the wider problems of the euro zone. They’re going from bad to worse,” John Wraith, a fixed-income strategist at Bank of America Merrill Lynch (BAC), said in an interview on Bloomberg Television. The European Financial Stability Facility (ESFS), which raises money to fund the bailouts of euro-area countries, could also be at risk of a downgrade, Wraith said.
Indeed, the ESFS on Nov. 20 had to delay a planned bond sale after the French downgrade. The transaction was pulled because so-called deeds of guarantee require new bond issues to be covered by member states with ratings similar or better than the ESFS’s own AAA rating.
Officials in France and Germany sought to downplay the Moody’s action. “Our most important partner has received a little bit of an admonishing assessment from a rating agency, but France’s rating is still very stable,” German Finance Minister Wolfgang Schäuble said in a speech to the parliament in Berlin. French Finance Minister Pierre Moscovici told reporters in Paris that France remained “one of the top-rated countries,” and blamed the situation on the policies of the previous government.
Still, the downgrade is a blow to President François Hollande’s six-month-old government, which is struggling with rising unemployment and weak growth. Adding to the gloom, the national statistics office said on Nov. 20 that French industrial orders declined in most sectors during September, and manufacturing output was down 2.5 percent year-on-year.
Moody’s said its action reflected France’s “multiple structural challenges,” including a rigid labor market and “sustained loss of competitiveness.” The ratings agency warned that France could face further downgrades “in the event of additional material deterioration in the country’s economic prospects or difficulties in implementing reform.”
Hollande recently announced plans to offer €20 billion in tax credits to business to help ease labor costs, but French corporate executives say the measure doesn’t do enough to restore competitiveness.
The Moody’s action also could weaken Hollande’s hand in European budget talks. “This downgrade will certainly increase pressure on France, big-time,” Jan Techau, director of the Carnegie Endowment for International Peace office in Brussels, told Bloomberg News. “It gives Germany more of an edge over France.”
