A French downgrade is bad for Sarkozy and Germany

We’ve been waiting for Standard & Poor’s decision since the new year began – they fired a warning late last year that many of the eurozone countries that still retained AAA ratings would lose them unless Europe’s central bank, the ECB, stepped up and became far more active in its rescue efforts. If reports coming from French and Austrian media are correct, S&P’s patience has run out. It is S&P’s method to announce these things on a Friday night after the market closes and they tend to inform the host government a day or so in advance, which is why we should take very credibly the media claims. 

This is of huge significance to the eurozone‘s fitful efforts at a long-lasting rescue. The AAA rating of France is absolutely fundamental to the current rescue plan – a complicated piece of financial engineering called the European Financial Stability Facility or EFSF. Basically, that method sought to lend on France’s AAA rating to better countries like Ireland and Portugal but clearly that becomes rather difficult if France doesn’t have an AAA rating. The net impact of all of this is to raise the burden hugely on Germany, making real what has always been clear – which is that Germany has a lonely decision to make as to whether to write a very large cheque drawn from Berlin or contemplate allowing the ECB in Frankfurt to engage in much more US and UK style aggressive moves such as buying up govt debt. That’s been anathema to Germany – will the S&P downgrade change things?

France’s AAA rating has also achieved totemic status in the French presidential election campaign – so it is a bad day for President Sarkozy, and a good day for his socialist rival Francois Hollande. And that too could complicate the mechanics of the euro rescue. Put together with signs that Greek government talks with bankers are going badly, this is the day that the euro crisis burst into 2012 with a vengeance.

A final thought for those harbouring schadenfreude from the UK – it’s only really the fact that the Bank of England is buying up such a huge proportion of Britain’s debt that is saving us. It wouldn’t take much of an increase in the temp of the euro crisis for Britain to follow.

Follow Faisal Islam on Twitter: @faisalislam