France and Austria lost their top credit ratings at Standard& Poor's in a swathe of downgrades that left Germany with theeuro area's only stable AAA grade, hindering leaders' efforts tostem the region's fiscal crisis.

France and Austria were cut one level to AA+ from AAA and facethe risk of further reductions, the rating company said inFrankfurt today. While Finland, the Netherlands and Luxembourg kepttheir AAA ratings, they were put on negative watch. Spain and Italywere also downgraded. The first gauge of the report's impact willcome on Jan. 16 when France sells as much as 8.7 billion euros ($11billion) in bills.

“In our view, the policy initiatives taken by European policymakers in recent weeks may be insufficient to fully address ongoingsystemic stresses in the euro zone,” S&P said in astatement.

S&P acted at the end of a week in which signs grew thatEurope's woes may be cresting as borrowing costs fell, evidence ofeconomic resilience emerged and the European Central Bank said ithad quelled a credit crunch at banks. While France's downgrade maymake it harder for the euro region's bailout fund to raise money infinancial markets, the immediate impact on French and Italian bondyields was muted.

“I'm not convinced that the downgrades will have a massivemarket impact,” said Jonathan Loynes, chief European economist atCapital Economics Ltd. in London. “It does further underline thefact that the fiscal crisis is no longer confirmed just to thesmall peripheral economies.”

European leaders are struggling to tame a crisis now in itsthird year and convince investors they can restore budget order.Greece's creditors today suspended talks with its government havingfailed to agree with its authorities about how much money investorswill lose by swapping the nation's bonds, increasing the risk ofthe euro-area's first sovereign default.

The euro today fell to its weakest in 16 months against thedollar, declining to $1.2665. The yield on Germany's benchmark10-year bund slipped 7 basis points to 1.759 percent and earliertouched a record low.

Regional finance ministers sought to play down S&P'sdecision or turn it to their advantage as European leaders prepareto meet for the first time this year on Jan. 30.

“It's not a catastrophe,” French Finance Minister FrancoisBaroin told France 2 television, noting his country now has thesame rating as the U.S.

Schaeuble's Comments

Wolfgang Schaeuble, his German counterpart, said the shiftsvindicated governments' decision last month to bring forward apermanent bailout fund to this year from 2013 and strengthenedGermany's determination to stabilize the euro region by instillingstricter budget discipline.

“We know that there's uncertainty with respect to the euroarea,” he told reporters in the northern German port city ofKiel.

The French and Austrian downgrades threaten the potency of theregion's current rescue program, which currently has a capacity of440 billion euros ($558 billion). The European Financial StabilityFacility, which is funding rescue packages for Greece, Ireland andPortugal partially with bond sales, owes its AAA rating toguarantees from the region's top-rated nations.

The French downgrade and refusal by governments to provide morecredit enhancements would still reduce the fund's lending capacityby around a third to 293 billion euros, Trevor Cullinan, S&P'sdirector of sovereign ratings, said last month.

“It will be interesting to see what the strategy will beregarding the EFSF,” said David Schnautz, a fixed-income strategistat Commerzbank AG in London. Downgrades could “limit the volume ofAAA-rated EFSF paper that could be issued, or the EFSF could beginto issue non-AAA.”

Downgrades sometimes lack bite. The yield on the benchmark U.S.government bond fell to a record 1.6714 percent on Sept. 23, sevenweeks after S&P withdrew its AAA rating for the first time,citing the nation's political process and a failure to tackle arecord budget deficit.

The impasse in Greece's debt-swap talks comes three months sinceofficials and creditors agreed to implement a 50 percent cut in theface value of the country's debt, with a goal of paring Greek'sborrowings to 120 percent of gross domestic product by 2020.Unresolved is the coupon and maturity of the new bonds to determinethe total losses for investors.

Greek Impasse

Proposals put forward by a committee representing financialfirms have “not produced a constructive consolidated response byall parties,” the Washington-based Institute of InternationalFinance said in a statement today. “Discussions with Greece and theofficial sector are paused for reflection on the benefits of avoluntary approach.”

The government said the two sides will reconvene discussions infive days. European governments have been pushing for the Greekdebt to carry a coupon of 4 percent, a person with direct knowledgeof the negotiations said this week. Private bondholders said theywould accept those terms for a period of time if they were able toget a bigger payout later as Greece's economy recovered, the personsaid.

The Greek bond due October 2022 rose, pushing the yield sixbasis points lower to 34.36 percent at 5:20 p.m. London time. Theprice climbed to about 20.5 percent of face value.

The French downgrade strikes a blow to President NicolasSarkozy's bid for re-election after he sought to protect hisgovernment's creditworthiness by announcing tax increases andspending cuts. He trails his main rival, Socialist Party candidateFrancois Hollande, by about 14 points in voting intentions for thesecond round of the election in May, according to a BVA poll for LeParisien newspaper published Jan. 9.

Prior to S&P's announcement investors had eased the coststhey were imposing on Italy and Spain to borrow, sparkingspeculation the worst of the crisis may be passing. ECB PresidentMario Draghi said yesterday the central bank had averted a seriouscredit shortage and economy is stabilizing with data showingrebounds in German exports and French business confidence.

“The markets were due a pullback considering the bullishness wehave seen this week looked overdone,” said Richard Driver, ananalyst for Caxton FX.

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