How Will the EFSF Downgrades Affect the Pound

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How Will the EFSF Downgrades Affect the Pound?

The recent downgrades of several European countries by the S&P have spelled bad news for these economies but there is a bigger picture to consider too. The EFSF bears the brunt of the impact. But, these downgrades have also had and will continue to have an impact on the entire European market in general, and consequently on the Euro.

Those analysts who were quite happy with the fact that the U.K. has retained its grading have no choice but to admit that downgrade or not, the U.K. market is reeling. Binary options traders focussing on currency trades involving the Euro should understand exactly what the downgrades mean for the EFSF and for the Euro.

The French and Austrian Connection

In spite of its recent downgrade to double A+, France still holds considerable clout in the market. The AA+ rating is actually quite a strong rating considering that the nation is expected to have an 85% of GDP government debt figure and a budget deficit exceeding 5% for 2020. This nation carries a fifth of the funding guarantee in the EFSF and any such downgrades are bound on reflect on the bail out fund too.

Austria was also part of the EFSF’s line up of six countries that originally had triple A ratings. The rating downgrade brought this nation to the double A+ right alongside France.

Italy’s Woes

When compared with France, Italy is in far worse shape with its brand new BBB+ rating, a two step downgrade. Hovering close to undesirable status and nowhere near improving its debt position, this nation seems to be in bad straits indeed. Two of the other nations that also suffered double notch downgrades, Spain and Portugal, are not as bad off as Italy owing to various other factors.

How is the EFSF Impacted?

To put it simply, there are simply not enough Triple A guarantors backing the fund post downgrades. This has lead to the downgraded AA+ rating given to the fund itself. This downgrade may translate into difficulties in raising money cheaply to aid stricken Eurozone nations. Given the high level of anticipation that the EFSF generated as the possible ‘saviour’ of these nations, this comes as a real disappointment to many.

There is still hope though. The S&P is quite willing to upgrade the EFSF rating if the fund manages to find new guarantees from stable nations to make up for the ‘fall from grace’. Otherwise, the size of the fund could be reduced so that the existing guarantees cover it adequately.

Until then, for Euro based binary options, the continuing uncertainty in the Eurozone fortunes is not good news and the currency is most likely to stay subdued. Traders should avoid risk sell offs until there is some clarity on what exactly is going to happen now.

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Friday’s downgrades could hurt the EFSF

Haier Brain Wave: The headset can sense if the user wants something on a TV set to go up or down. Source: AP

Highlights

  • The government will release December 2020 wholesale price index data. A NDTV Poll suggests WPI is expected to be at 7.4 per cent against 9.1 per cent in November 2020.

S&P warned in December that any downgrade of one of the six triple-A nations could affect the EFSF’s own top rating.

Luxembourg Prime Minister Jean-Claude Juncker, head of eurozone finance ministers, said governments would “explore the options for maintaining the EFSF’s AAA rating.”

Backed by guarantees from eurozone states, the fund borrows from investors at cheap rates and then lends that money to nations that have been shut out of the private markets.

A drop in the fund’s credit rating may therefore lead investors to impose higher lending rates.

A new permanent fund, the European Stability Mechanism, is due to be activated in July with its own capital base of 500 billion euros. Governments are divided over whether to increase its size, with some wary of tapping on taxpayers.

For analysts, Friday’s bad news is a stark reminder that the crisis is far from over.

“The downgrade does not reflect the fact that the efforts of the eurozone to escape the crisis had shown some promising positive results,” said Janis Emmanouilidis, analyst at the European Policy Centre.

“At the same time, the downgrade shows that more needs to be done to manage and eventually overcome the crisis.”

EFSF downgrade could affect Ireland

AN UNPRECEDENTED potential mass downgrade of European countries, and in turn the European Financial Stability Facility (EFSF), is likely to have only a limited impact on the euro zone. However, an increase in the cost of funding for the EFSF could have a knock-on effect for Ireland.

On Monday night, Standard & Poor’s (S&P) put 15 euro area members, including Ireland, on “credit-watch negative”, citing, among other things, higher risk premiums, disagreement at a political level and the rising risk of recession in the euro zone in 2020.

The rating agency followed this with an announcement yesterday that it had put the EFSF’s AAA rating on review for a possible downgrade, depending on the outcome of this week’s EU summit.

“We could lower the long-term credit rating on EFSF by one or two notches if we were to lower the AAA sovereign ratings, which are currently on credit watch, on one or more of EFSF’s guarantor members,” S&P said.

However, analysts suggest that, even if the downgrades go ahead, the impact is likely to be limited as markets have already factored in such moves.

“The market has been anticipating this for some time,” said Goodbody Stockbrokers chief economist Dermot O’Leary.

“As we’ve learned, markets move in anticipation of rating agencies’ changes – not when they do them.”

However, a downgrade may push up the cost of funding for Ireland. According to Mr O’Leary, a 1 per cent increase in the cost of funding for the EFSF could result in a € 200 million increase in the cost of funding for Ireland.

But it is not certain that a downgrade will push up the cost of funding for the EFSF.

Davy stockbrokers chief economist Conall MacCoille said the cost of funding for the US had continued to fall, despite it losing its AAA status in August.

Moreover, if the European Central Bank is charged with a more aggressive bond-buying programme, this in turn could put downward pressure on yields.

On Monday, French president Nicolas Sarkozy and German chancellor Angela Merkel backtracked on the decision to include private-sector involvement, which was used in the Greek sovereign debt writedown, in any future bailout deals. This could pave the way for a more involved role by the ECB in European bond markets.

By taking private-sector involvement out of the European Stability Mechanism (ESM), it means that if Ireland cannot get back to the market in 2020 as planned, it will be able to get some sort of additional funding from the ESM, the launch of which may be brought forward to 2020.

“It is now more likely that Ireland will be able to tap into the ESM for funds should market funding not be available at sustainable rates by that stage,” said Mr O’Leary.

The assertion on private-sector involvement does, however, also make a restructuring of Irish sovereign bonds less likely, although the possibility of renegotiating the €30 billion in promissory notes, which accounts for about 20 per cent of Ireland’s total outstanding debt, remains open.

“In some senses we’re lucky that a large proportion of our debt is in promissory notes, as it means that you can restructure a large element of debt without debt writedowns,” said Mr MacCoille.

S&P’s announcement has also called into question the role of such agencies, according to Mr MacCoille.

“Rating agencies now merely reflect market sentiment rather than giving an independent review,” he said.

If Ireland is downgraded again, a maximum two-notch downgrade would still mean Ireland’s rating will remain in the investment-grade category at BBB.

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