AAA downgrade could deepen France-Germany rift, says Capital Economics

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France’s downgrade by ratings agency Moody’s could deepen the political rift with Germany, although the direct effect of the downgrade “should be modest” reports Capital Economics.

Senior European economist Jennifer McKeown says the downgrade could make it more difficult for policies to tackle the eurozone debt crisis to be agreed.

McKeown says the Moody’s France downgrade could cut the lending capacity for the European Financial Stability Facitily and European Stability Mechanism, as ratings agencies have warned the top ratings will be only be awarded if they are matched by guarantees from top-rated governments.

“The loss of France’s 20 per cent contribution to the funds’ remaining lending capacity of about €440bn would be a serious blow,” she says.

“The EFSF and ESM could accept a downgrade. But this would mean an increase in their borrowing costs, which would presumably have to be passed on to troubled nations in the form of less generous loans.”

McKeown says the downgrade could have serious implications for the French economy and the need for further austerity measures.

The economist says any measures improving competitiveness “are likely to have a damaging effect in the nearer term” although boosting future growth.

She adds: “Given this and French banks’ still high exposures to the periphery, we still see the economy shrinking by as much as 2 per cent next year.” columnist Daniel Ben-Ami recently highlighted the issue of strained relations between France and Germany over several key issues facing the eurozone.