France’s Credit Rating Under Scrutiny, Debt Targets to be Reassessed

French President Nicolas Sarkozy has said his government will explore new measures to reduce the size of France’s public deficit amid concerns it could face a debt downgrade. The move came as shares in France’s banks tumbled amid concerns over stability in the continuing market turmoil.

French President Nicolas Sarkozy has said his government will explore new measures to reduce the size of France’s public deficit amid concerns it could face a debt downgrade. The move came as shares in France’s banks tumbled amid concerns over stability in the continuing market turmoil.

The Financial Times reported that Mr Sarkozy summoned his key ministers back from holiday for an emergency meeting as concern mounted over prospects for growth and the country’s ability to meet its debt targets. In a bid to reassure nervous markets, Mr Sarkozy said these “pledges will be kept whatever the evolution of the economic situation”.

The meeting came as rumours circulated about French banks and the possibility of a French credit rating downgrade, with Société Générale plunging by as much as 23 per cent. It closed down 15 per cent, after it denied rumours over its financial stability, while Crédit Agricole was off 12 per cent and BNP Paribas down 9 per cent. Other European banks slumped too, with Italy’s Intesa Sanpaolo down 14 per cent. SocGen’s shares have fallen by third this month and by 45 per cent since the start of the year.

All three main rating agencies have reiterated that France’s AAA credit rating is stable, but several investors and analysts have said it could be next in line following the downgrade of the US from AAA to AA+ last Friday.

[quote] “Clearly the market is moving on to who is next in the AAA downgrades and the next one is France,” said Adrian Cattley, European equity strategist at Citi. [/quote]

But Didier Duret, chief investment officer at ABN Amro Private Banking, said:

[quote] “They need to put their public finances in order but it is a very short-term problem. You really don’t have the same political configuration as in the US, which is a big positive.” [/quote]

He called the sell-off brutal and unjustified but warned it could become “a self-fulfilling prophecy”.

One senior government official suggested the persistent rumours about a downgrade of French debt and the stability of the French banking sector were being fuelled by speculators. “There are people who have their own reasons for throwing rumours around about France,” he said.

A final decision on the scale of new spending cuts to be included in the budget for 2012 will be taken at a meeting between Mr Sarkozy and François Fillon, prime minister, on August 24.

Wednesday’s meeting was aimed at reassuring markets after credit default swaps – a form of investor protection that pay out in case of a default – reached a fresh record for France of 176 basis points. Italy and Belgium also hit record CDS levels despite continued European Central Bank purchases of Italian and Spanish debt.

The unexpected summons to senior ministers may have helped to fuel concerns over the stability of the French rating and the banking sector, though officials denied that it was anything more than a working meeting. “It may have added oil to the fire,” admitted one government official.

Stock markets globally plunged on the dour outlook for growth. The CAC-40 closed down 5.5 per cent and Germany’s Dax-30 fell 5.2 per cent. In lunchtime trading in New York, the S&P 500 fell 3 per cent, erasing much of the previous day’s gains.

US and German benchmark 10-year bond yields fell sharply to close at all-time lows as investors sought havens. The UK’s 10-year Gilts yields fell to a record low of 2.48 per cent, after the biggest one-day fall in 18 months of 24bp. French yields were also down at 3.07 per cent but the premium it pays to borrow over Berlin remained close to euro-era highs.

Nervousness in Paris is growing over the prospects for economic growth next year, amid a sharper than expected contraction in industrial production in June. Unicredit warned on Wednesday that its forecast for 0.2 per cent growth could be at risk. The official second quarter figures will be published on Friday.