EU bailout fund set for €1.5bn debt auction

EUROPE’S BAILOUT fund will attempt to shake off Standard & Poor’s downgrading of France and Austria by moving ahead tomorrow with a scheduled auction of €1.5 billion in short-term debt.

The removal of the French and Austrian triple-A ratings has potential to cut the European Financial Stability Facility’s firepower by as much as €180 billion, severely weakening its capacity to prop up stricken euro zone countries.

Still, the EU authorities have taken the view that there is no need for any emergency action in response to the S&P manoeuvre.

Their position will be tested as markets reopen after the weekend today, with officials on the alert for any increase in the borrowing costs of vulnerable euro countries.

A further challenge looms tomorrow when the EFSF goes to the market to sell up to €1.5 billion in six-month debt to help finance its Irish and Portuguese funding programmes.

The S&P manoeuvre deprives the EFSF of the benefit of two of six triple-A guarantees from the strongest euro zone countries.

There is little clarity, however, as to the immediate impact that this will have as S&P rivals Moody’s and Fitch continue to apply their top ratings on France and Austria.

At issue will be the interest rate determined by the market in the wake of the downgrades and level of investor demand for the debt.

A senior euro zone source said the authorities have taken some comfort from the fact that the response on European and US markets last Friday to news of the imminent downgrades by S&P might have been much worse.

The authorities believe the EFSF still has enough resources to hand to meet all its commitments under the Irish and Portuguese bailouts and a new set of responsibilities under a second rescue plan for Greece.

However, the euro zone source acknowledged that this stance would not hold if Italy or Spain were unable to fund themselves on private markets and were forced to seek external aid.

It was already the case, the source added, that the EU leaders planned in March to review the €500 billion “ceiling” on the firepower of the EFSF and the European Stability Mechanism, the permanent fund which is to replace the EFSF in June.

The ESM will have a more solid financial footing than the EFSF as it will take the benefit of capital contributions from euro zone countries when borrowing to fund any bailouts. The EFSF relies only on guarantees.

The EFSF’s triple-A rating was left untouched by S&P in its downgrade of France, Austria and seven other countries – among them Italy and Spain – that did not have the highest available rating.

However, S&P has warned that its top rating depends on the fund receiving additional support from Germany and the other three remaining triple-A countries: the Netherlands, Finland and Luxembourg.

Any downgrading of the fund would be likely to increase its borrowing cost leading to a knock-on increase in the interest rates paid by bailout recipients like Ireland.

Any appreciable increase could upset the Government’s budget calculations, which are finely balanced and predicated on the lower interest repayments foreseen when the interest rate Ireland pays to the EFSF was cut last summer.