Europe's rescue plan for the euro zone was thrown into further turmoil last night after France and Austria lost their triple-A credit ratings and talks were suspended on a deal to halve Greece’s national debt.
The manoeuvre by Standard & Poor’s rating agency has the potential to reduce the lending capacity of the European Financial Stability Facility (EFSF) by some €180 billion, drastically curtailing its power to prop up stricken member states.
Standard & Poor's decision was "expected," even if it was "disappointing given the advances that have been made in dealing with the crisis," French Prime Minister Francois Fillon said.
Speaking at a press conference in Paris this morning, Mr Fillon said the decision to strip France of its top rating shouldn't be "dramatized" nor "politicized." "The rating agencies won't decide our policies," he added.
"We haven't waited for them to take steps to cut our debt and boost our competitiveness."
S&P also downgraded seven other euro countries that do not have the highest available rating.
The countries concerned included Italy and Spain, which are trying to convince sceptics that they can continue to finance themselves on the open market.
Ireland escaped a new downgrade, although S&P said there was at least a one-in-three chance that the current Irish rating will be lowered this year or next.
The expectation of the agency's intervention, confirmed late last night after the closure of US markets, sent the euro to its lowest level against the dollar since the summer of 2010.
The move came hours after the break-up of the Greek talks, which increased the risk that the country might default on its debt in the coming weeks. Taken together, the two developments have raised yet more questions over the ability of EU leaders to assert control over the crisis.
S&P took issue with the initiatives the leaders took at a summit last month, suggesting they did not fully address the systemic stresses in the euro zone. "In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those euro zone sovereigns subjected to heightened market pressures."
This was disputed by EU economics commissioner Olli Rehn, who said the downgrades were "inconsistent" and regrettable at a time when Europe has taken decisive action on all fronts.
"These initiatives push forward the necessary fiscal consolidation and structural reform in our member states, address the fragilities of the banking sector, reinforce our financial backstops and strengthen our economic governance," he said.
S&P removed the threat of a downgrade from the other four triple-A countries in the euro zone: Germany, the Netherlands, Finland and Luxembourg.
However, a senior euro zone source suggested the EFSF could lose the benefit of the entire €158.5 billion triple-A guarantee backed by France and a €21.6 billion Austrian guarantee.
"You could partially compensate for some of this but clearly not all. It would have an impact on the lending capacity," the source said.
The source insisted, however, that the EFSF still has enough firepower to meet its commitments to Ireland and Portugal and any new commitments to Greece.
Still, the downgrades are also considered likely to increase the borrowing costs of the EFSF with a knock-on increase in the cost of the loans it makes to Ireland.
Even so, notional Irish borrowing costs continued to decline yesterday with generic nine-year debt trading at 7.8 per cent.
The French downgrade marks a serious political setback for French president Nicolas Sarkozy, who faces an election in April after placing the protection of the country's top rating at the centre of his economic strategy.
"It's not good news. We clearly would have preferred to have kept it," finance minister François Baroin said after a crisis meeting at the Élysée Palace.
Opposition figures portrayed the downgrade as a pivotal moment and an indictment of Mr Sarkozy's rule.