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France stares down barrel of credit downgrade

COMMENTARY The eurozone is starting the new year much like it ended the past one -- on the brink. A move by Standard & Poor's to lower France's AAA credit rating looks imminent, which would deepen the sovereign-debt crisis sweeping the monetary bloc.

With the French government scheduled later this week to raise up to 8 billion euros in a bond auction, concerns about the possible downgrade appeared on Tuesday to push up the interest rate on the country's debt. As one stock analyst tells The Wall Street Journal:

"Everybody's waiting to see what the ratings agencies are going to do. I think we'll get something within the next two weeks," said Mark Grant, managing director of Southwest Securities. "The question in everybody's mind is, 'Does Germany get downgraded, and does France lose one or two notches?'"

S&P warned in December that it was reviewing the credit rating of 15 of the eurozone's 17 member countries, along with some of Europe's biggest banks. For France, a downgrade would raise the government's borrowing costs at a time the country is already struggling with slowing growth, rising unemployment and other economic woes. That is putting French President Nicolas Sarkozy in a difficult squeeze. Facing a tight reelection battle in April, he is under pressure to commit his nation politically and financially to propping up the eurozone even as France's economy contracts.

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For Europe as a whole, a French downgrade would set off fresh fears that financial "contagion" is spreading across the region's biggest economies and hinder efforts to halt the epidemic. For instance, a dent in France's credit rating also would raise the borrowing costs of the European Financial Stability Fund, the rescue facility being counted on to bail out the eurozone's most troubled economies. The 500 million euro EFSF is already widely regarded as too small to backstop Spain, Italy or other larger European countries showing signs of distress, so new questions about France's ability to support the fund would heighten investor fear. That, in turn, would likely further raise borrowing costs across the eurozone.

In other words, France and the broader eurozone remains stuck in a self-reinforcing -- and self-inflicted, given the misguided use of fiscal "austerity" to spark growth -- cycle of decline. The "bond vigilantes" fronted by S&P and the other major credit rating agencies must be appeased, even as the fiscal measures investors demand deepen Europe's economic woes.