Market reaction to S&P’s EZ and EFSF downgrade warning better than expected

By Julia Pastor, in Madrid | Ratings agency S&P’s threat of downgrading the euro zone and the EFSF has fallen like a ton of bricks among leaders and European institutions. Santander analysts believe, however, that it has also been accepted with a certain degree of realism:

“The German Minister of finance, Schäuble, commented that the warning is the best incentive to promote a solution to the crisis and regain the confidence of the markets.”

And the markets? What have they said? According to experts of Barclays in Spain,

“they have reacted more positively than expected.”

For Santander, moreover,

“the announcement of S&P has reminded us that the situation is still complex and the EZ needs wide firewalls. Hence, the possibility of launching two new rescue vehicles is excellent news that would offset the unexpected downgrade by agency S&P.”

The idea that could be considered is to maintain the existing the EFSF beyond its expiration date (the date of entry of the ESM). The EFSF would exist in parallel after the launch in mid-2012 of the ESM (€500bn). In addition, the ESM would be given more access to liquidity. In this way, the ESM could have access to the ECB since would be an international organisation like the IMF or the EIB, which do have access.

Still, analysts believe that it is important we should not forget two issues:

(1) the ESM will be financed not by guarantees but with cash contributions, i.e. it would require new issues from countries, and therefore time and much effort until it is properly set up;

(2) the idea that the ESM include ACC clauses seems to still be present although the language of private contribution in the event of a rescue can be softened.

With regard to the market reaction to threats from S&P, in the opinion of analysts from Barclays,

“those who thought that the ECB had to act nakedly to convince the market and that the rest was secondary were wrong; that is to say, we overestimated the conviction and perseverance of the market in its ideas and we let ourselves be carried away by the interested pessimism so eloquently aired by the Anglo-Saxon press (why is there no Spanish, French or German economic press in English?).”

“Finally, it has been enough that Draghi insinuated that he would be willing to accept greater commitment if States made a greater fiscal effort, for the markets to decide to fold their sails and stop betting against Italy or Spain. This, and that Italy finally does its homework, and that Merkel and Sarkozy bring their positions close enough so that one can speak of a certain degree of leadership.”