France joining the periphery...surely not! Concerns are mounting that France, Europe’s second-largest economy, may run into debt troubles and face a possible downgrade from its rating of AAA. Nicolas Sarkozy, the French president, last week summoned his ministers back from holiday for an emergency meeting – he has given his finance and budget ministers a week to devise new measures to cut France’s budget deficit. The concerns about France have undermined European equities in recent days. European bank stocks were among the hardest hit, falling last week to their lowest in almost 2½ years. But is this angst justified? All three major rating agencies have reaffirmed France’s AAA rating and stable outlook. Speculators seem to be testing the perceived weak points of the eurozone sovereign debt market and attention shifted to France after the European Central Bank supported Italian and Spanish sovereign bond markets by buying the debt of the these countries. On Thursday, France, Italy, Spain and Belgium banned all short selling in response to what many view as rampant speculation and the spreading of false rumours. This mirrored what happened when the global financial crisis intensified in September 2008. There is no question that Europe’s banks are finding short-term financing harder to come by, and there are concerns that this problem could intensify. Banks’ overnight borrowings from the ECB jumped to the highest in three months yesterday, a sign some lenders may have need for emergency cash. There are also worries that banks in core Europe (most notably France) have too much exposure to peripheral sovereign debt. French banks, such as Société Generale, Crédit Agricole and BNP Paribas have seen some weakness in their share prices in recent days. But this is not 2008. Bank balance sheets are stronger and far more transparent than they were prior to the financial crisis. Banks are far better capitalised than they were in 2008 and they are still recapitalising ahead of Basel III. Despite speculation over a US dollar funding squeeze on European banks, they have access to unlimited US dollars through the ECB (a swap facility). They are not using this facility because it is still cheaper to do so on the open market. It’s worth remembering too that few European banks failed the recent EU bank stress tests. Bond investors seem to think that France is a relatively safe bet. Ten-year French bonds ended the week trading at 2.97% compared with 5.00% for Spanish bonds, 5.02% for Italian bonds and 2.33% for German bonds. Credit default swaps on French government debt are also much lower than those on government debt issued by Spain and Italy, as the graph below shows.

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