S&P action dents stocks, euro ahead of EU summit

NEW YORK: Global stocks and the euro weakened on Tuesday after S&P warned of a possible downgrade for 15 euro zone nations, though analysts expressed cautious hope the move would spur European leaders into more decisive action to tackle the region's debt crisis.

Even so, the optimism was tenuous and measures of financial risk remained elevated with banks increasingly reluctant to lend to each other.

Standard & Poor's warned late Monday it could cut credit ratings across the euro zone, including the top-tier ratings of Germany and France, the region's two biggest economies, underscoring just what is at stake ahead of a European Union summit this week.

It could also help Germany and France force through proposed treaty changes that would allow the imposition of mandatory penalties on countries that exceed deficit targets.

The timing of S&P's announcement and the inclusion of euro zone economic powerhouse Germany among the 15 countries facing ratings cut put the focus firmly on the need for this week's EU summit to deliver.

"There's an idea the S&P warning is likely to push the EU to work harder at solving its debt crisis," said Rick Meckler, president of investment firm Liberty View Capital Management in New York.

"It may have the impact of pushing forward the solution without having to be an actual problem to the market."

A ratings downgrade could automatically require some funds to sell bonds of affected states, making those countries' borrowing costs rise still further.

It could also make banks less willing to lend to each other, leading to a credit squeeze. On Tuesday, the spread between three-month euro Libor rates and overnight indexed swap rates - an indicator of financial stress - stood at 92 basis points, near an almost three-year high of 93 basis points hit on Dec. 1.

Uncertainty over whether policy makers will be able to contain the euro zone debt crisis halted a six-session run for global stocks with the MSCI world equity index down 0.8 percent. US and European shares fell.

"We've seen a pattern where there has been talk of an agreement, and when it comes down to the details there's nothing substantial at all," said Peter Jankovskis, co-chief investment officer at OakBrook Investments in Lisle, Illinois.

Still, he said S&P's warning "is viewed as something that could hold leaders' feet to the fire and force them to go through with a comprehensive solution" for the European debt crisis.

US Treasury Secretary Timothy Geithner, who was in Germany to meet with EU leaders ahead of Friday's summit, said the European Central Bank was playing a positive role in the euro zone debt crisis, but he played down talk that the US Federal Reserve could boost funding of the International Monetary Fund for the crisis.

The Dow Jones industrial average edged up 22.97 points, or 0.19 percent, at 12,120.80. The Standard & Poor's 500 Index dipped 2.33 points, or 0.19 percent, to 1,254.75. The Nasdaq Composite Index fell 13.76 points, or 0.52 percent, to 2,642.00.

European stocks as measured by the FTSEurofirst 300 unofficially ended down 0.2 percent, a day after notching a five-week high.

The euro slipped against the dollar for the third day in a row in choppy trade. The euro was down 0.2 percent at $1.3378, with the session low at $1.3332, according to Reuters data.

"The state of markets is that they are still ripe for consolidation especially until Friday's EU summit," said Alexander Chepurko, foreign exchange analyst at Forex Club.

"There is simply too much European drama going about and now S&P has joined the political debate by offering its opinion right on the eve of the summit."

Separately, the EU said the euro zone's economy grew an anemic 0.2 percent in the third quarter, giving grounds for the European Central Bank to cut interest rates at its policy meeting on Thursday.

A Reuters survey of 73 analysts showed a 60 percent chance the ECB will cut rates by 25 basis points to a record low of 1.0 percent on Thursday.

The ECB is also likely to offer ultra-long liquidity operations to support banks, while leaving the door open to further measures to fight Europe's debt crisis if governments agree fiscal reforms, the survey showed.

Copyright Reuters, 2011