The European financial crisis has moved into a new phase after Standard & Poor's cut the credit rating on nine euro zone countries, and Greece's debt talks collapsed without agreement. The long-awaited loss of France's AAA was the most high-profile move from S&P, which also cut Austria's triple-A rating and pushed Portugal and Cyprus into junk status. S&P's move, which was rumored for most of the afternoon, is a major embarrassment for Nicolas Sarkozy, and will also undermine Europe's bailout fund. There is a one-in-three chance of France being downgraded again by the end of 2013. S&P criticized European leaders for not making more progress, and criticized the focus on austerity. Fiscal cutbacks alone, it said, will not solve Europe's problems and could make the crisis even worse. The nine countries downgraded were France, Austria, Malta, Slovena, the Slovak Republic, Spain, Italy, Portugal and Cyprus (details here). Meanwhile in Greece, the body representing private creditors admitted that it was struggling to reach a deal over the Greek debt reduction program. The news that talks had broken up without agreement was seen as very serious by several analysts, as it makes a disorderly default more likely. The double-dose of bad news sent shares falling and pushed the euro to a 16-month low against the dollar. There was little good news - although an auction of Italian bonds did go pretty well.
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Three months of negotiations ground to a halt on Friday night, amid a wave of downgrades by ratings agency Standard & Poor’s aimed at a clutch of European countries, including France.
The unexpected breakdown in talks between Greece and its private-sector creditors has taken the country a step closer to bankruptcy after a failure to sign up lenders to a voluntary and “orderly” 50pc haircut to their holdings.
Greece’s finance minister Evangelos Venizelos said talks would resume on Wednesday to “bridge differences” but insiders remained sceptical that a deal could be stitched at such a late stage.
The clock is ticking for Greece, as a deal must be reached before March 20, when the country is due to receive a further €130bn (£107bn) bail-out tranche from the International Monetary Fund and must make a key €14.5bn bond payment.
The problem centres on the difference between lenders agreeing to a “voluntary” and orderly default – which would mean swapping into bonds with a lower value – and lenders refusing terms, which would cause a default.
As global stock markets brace themselves for aftershocks following Friday night’s downgrades of the credit ratings of nine eurozone nations including France, the Ernst & Young ITEM Club will say in its winter forecast published tomorrow that falling disposable incomes, higher unemployment and stagnating business investment will all weigh on the British economy in 2012.
“Figures for the last quarter of 2011 and the first quarter of this year are likely to show that we are back in recession and we are going to have to wait until this summer before there are any signs of improvement,” said Peter Spencer, chief economic advisor to ITEM.
“But it’s not going to be a repeat of 2009; we are not going to see a serious double dip,” he added.
Mr Spencer said British companies were in better shape this time around, with stronger balance sheets and better cash positions as insurance against a further downturn. But he estimates business investment fell by 2.6pc in 2011 and will grow by just 0.4pc in 2012.
ITEM is forecasting that in the absence of a eurozone shock, the UK economy will just about scrape growth of 0.2pc this year, before growing 1.8pc and 2.8pc in 2013 and 2014 respectively. Unemployment is expected to rise sharply to almost 3m in the first half of 2013, from a current level of 2.64m.
On Friday evening, the Washington-based Institute of International Finance (IIF), which represents bondholders, said that talks had not produced a “constructive consolidated response by all parties”. The IIF had aimed to implement a swap into new bonds this month. But the two sides still have to agree on the coupon and maturity of the new bonds to determine losses for investors.
The breakdown in talks has been described as “catastrophic” by insiders, who say the repercussions of a default would be felt not just by Greece but by all of Europe.
The bond-swap deal, which aims to cut Greece’s debt pile by €100bn (£82bn), is part of the condition for freeing up €130bn of further rescue funds for the near-insolvent nation. Greece’s credit rating did not change on Friday in S&P’s review of eurozone countries, as it is already considered to be deep into “junk” status.
Lucas Papademos, the Greek prime minister, said the new aid package and bondholder talks were linked and each needed to succeed for Greece to survive. “Neither deal can stand on its own. One is a condition for the other,” he said in a speech on Friday night.
“We are fully aware of how critical the situation is. Until these negotiations are completed, we face dire economic dangers.”
However, Mr Venizelos last week insisted that the threat of a disorderly default could be averted within weeks and that bond swap negotiations could yet be salvaged.
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