Rating agency issues warning of downgrade for Europe

Six countries with AAA ratings are facing a 50% chance of seeing their ratings downgraded, including Germany and France, while other countries including Malta have also been warned.

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.

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 8-9 December 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.

New-York based Granite Springs Asset Management LLP's Vince Trugila, also a former head of the sovereign risk unit at rival Moody's, described S&P's move as "excessive", saying that countries like Germany, Luxembourg, the Netherlands, Finland and Austria are strong AAA.  

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."

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.

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.

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.

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.