France said its economy was sound and reforms were on track after credit ratings agency Moody's stripped it of the prized triple-A badge due to an uncertain fiscal and economic outlook.
Monday's downgrade, which follows a cut by Standard & Poor's in January, was expected but is a blow to Socialist President Francois Hollande as he tries to fix France's finances and revive the euro zone's second largest economy.
"The rating change does not call into question the economic fundamentals of our country, the efforts undertaken by the government or our creditworthiness," Finance Minister Pierre Moscovici told a news conference on Tuesday.
The downgrade to Aa1 with a negative outlook sent the euro 0.30 percent lower to 1.2770 against the dollar late on Monday but the currency recovered some ground to trade at 1.2795 early on Tuesday.
Wider market reaction was also limited with futures on French OAT government bonds down 0.25 pct and French CAC stock futures down 0.22 pct, in line with German DAX futures which fell 0.25 percent.
The benchmark French 10-year government bond yield was barely changed at 2.09 percent versus 2.08 percent before the downgrade. "This was priced in, really. The market has been expecting it for more than a year now. It might have an impact on the short term, but it won't last. All in all, CAC 40 companies are big multinationals, they won't be impacted by this," said David Thebault, head of quantitative sales trading at Global Equities.
France, a core member of the euro zone, has been borrowing at historic low levels of around 2 percent for long-term bonds as investors consider it a safe haven from the turbulence in southern countries such as Greece and Spain.Yet Moody's said it was keeping a negative outlook on France due to structural challenges and a "sustained loss of competitiveness" in the country, where business leaders blame high labour charges for flagging exports.
"The first driver underlying Moody's one-notch downgrade of France's sovereign rating is the risk to economic growth, and therefore to the government's finances, posed by the country's persistent structural economic challenges," Moody's said.
"These include the rigidities in labour and services markets, and low levels of innovation, which continue to drive France's gradual but sustained loss of competitiveness and the gradual erosion of its export-oriented industrial base." Moscovici told Reuters late on Monday the downgrade was a motivation for the 6- month-old Socialist government to pursue reforms, but he noted that even after the S&P downgrade French debt has enjoyed record low yields. He also said the government was committed to meeting its target of cutting the public debt to 3 percent of economic output next year from an estimated 4.5 percent this year.
"There is probably more downside until the knee jerk reaction is out of the way. But on the whole it seems likely that this more reflects an existing reality than new information for the market," said Steven Englander, global head of G10 FX strategy at Citi.
Moody's had been waiting to examine Hollande's 2013 budget and his response to a review of industrial competitiveness before adjusting its view on France as a sovereign borrower.Standard & Poor's has rated France AA-plus, with a negative outlook, since downgrading it by one notch in January. Fitch Ratings still has France at AAA, also with a negative outlook. The loss of its AAA rating from two agencies poses a problem for France, as investment funds often require their best assets to have at least two top notch ratings to remain in their portfolios.
Any rise in borrowing costs will be painful as the French government is already battling to rein in its deficit with potentially painful cuts to public spending."France is paying the price for not engaging in reform," said
Axel Merk, president of Merk Investments in Palo Alto, California, saying he was not surprised by the downgrade. With France's 2 trillion euro economy teetering on the brink
of recession, Hollande surprised many this month by unveiling measures to spur industrial competitiveness, chief among them the granting of 20 billion euros in annual tax relief to companies, equivalent to a 6 percent cut in labour costs.
The government had already announced 30 billion euros in budget savings next year in an effort to meet its deficit goal and is working on reforms to labour laws to enable companies to hire and fire more easily with economic swings.