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Spain's credit rating cut; deal said near on European rescue fund

October 18, 2011 |  3:38 pm

Spain
While European leaders continue to hash out how to solve their government-debt crisis once and (hopefully) for all, the credit-rating firms keep hacking away.

Spain’s rating was slashed Tuesday to A1 from Aa2 by Moody’s Investors Service, putting the country on par with the much smaller nations of Slovakia, Estonia and Oman.

Late last week, Moody’s rival Fitch Ratings cut Spain to AA- from AA+ and Italy to A+ from AA-. And a few days before that, Moody’s cut Italy’s rating to A2 from Aa2.

The downgrade of Spain occurred just a couple hours after London’s Guardian newspaper reported that Germany and France had reached an agreement to boost Europe’s financial rescue fund to 2 trillion euros, or about $2.7 trillion, from the current $600 billion.

That report triggered a surge in U.S. stock prices. The Dow Jones industrial average finished the day up 180.05 points, or 1.6%, to 11,577.05.

Yet just a day earlier, the Dow had slumped 247 points after a spokesman for German Chancellor Angela Merkel warned against expecting that “everything will be resolved” at a meeting this weekend of European leaders.

Markets are doing little more than trading off headlines, in some cases minute by minute.

The Guardian said that the new rescue fund, the European Financial Stability Facility, would be able to issue guarantees to holders of European sovereign or private bonds (such as bank debt), thereby boosting the fund’s firepower.

The idea would be to give bond investors confidence that they won’t face losses, which in turn could bring down the high borrowing costs that Spain, Portugal and other troubled countries have been forced to pay as markets have feared a rash of defaults.

Moody’s downgrade of Spain will put more pressure on European leaders to come up with a definitive plan at this weekend’s summit. Moody’s said its decision to cut Spain’s rating was triggered in part because “no credible resolution of the current sovereign debt crisis has emerged.” The firm also warned that Spain’s economic growth outlook is waning. Moody’s expects real gross domestic product growth of 1% “at best” for Spain in 2012.

Falling credit ratings can further drive up countries’ cost of borrowing. On Tuesday, the market yield on 10-year French government bonds jumped to 3.14%, up from 3.05% on Monday and up from 2.48% on Sept. 9, after Moody’s late Monday said France’s Aaa debt rating could be in jeopardy if the cost of a Eurozone bailout becomes a heavy burden on France’s finances.

The risk of France losing the top credit rating further raises the stakes for this weekend’s European summit: With France and Germany considered Europe’s economic core -- and therefore the principal backers of the rescue fund for the continent's struggling states and banks -- the credibility of the fund rests on the credibility of French and German finances.

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-- Tom Petruno

Follow me on Twitter: Twitter.com/tpetruno

Photo: Spain's King Juan Carlos signs a constitutional amendment in late September putting a cap on future budget deficits, as part of Spain's efforts to assure its bondholders. Credit: EPA

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