Gallic shrug for Moody's downgrade Within days of the French finance minister insisting that his country was "not the sick man of Europe," Moody's stripped Paris of its triple-A credit rating and said further downgrades could be on the way. The rating agency highlighted France's "persistent structural economic challenges," declining competitiveness, fiscal deficits, indebtedness, exposure to the eurozone crisis and the rising contingent liabilities incurred through crisis-fighting measures. Yet, for now, investors seem to agree with the French finance minister, Pierre Moscovici. Despite the undoubted challenges faced by France, its borrowing costs are near record lows; hardly the hallmark of a continental invalid. The Moody's downgrade sent France's benchmark 10-year bond yield slightly higher on Tuesday, but the move was largely in line with higher yields, which move inversely to prices, for German Bunds and UK gilts as well. French credit default swaps, a measure of the cost of insuring against default, remained below 100 basis points, half the levels seen in the summer. "The downgrade came earlier than expected, but it wasn't a surprise at all," points out Tanguy Le Saout, head of European fixed income at Pioneer Investments. France needs reforms, but it is still a rich and stable country. The immediate impact on the domestic financial sector should also be minimal. Steve Hussey, head of financial institutions credit research at AllianceBernstein, says there is still a sizeable gap between the rating of French lenders and their sovereign. He does not anticipate immediate downgrades for banks. EFSF forced to delay three-year bond sale The European Financial Stability Facility, one of the eurozone's rescue funds, was forced to delay a three-year bond sale yesterday after Moody's downgraded the credit rating of France, one of the fund's biggest backers, writes Robin Wigglesworth. Although the downgrade only had a muted impact on France's government bond market, the shelving of the EFSF bond sale underscores how the eurozone depends on the heft of a shrinking club of top-rated, fiscally strong countries at Europe's core. The transaction was delayed because the so-called "deeds of guarantee" in the bonds require that new issues are covered by member states with ratings similar to or better than the fund's own grade, the EFSF said in a statement. "EFSF will look to bring its new three-year euro benchmark offering once the issuer is able to satisfy the deeds of guarantee language," said Christophe Frankel, EFSF's chief financial officer. The EFSF could also be directly affected by the French downgrade. Moody's still rates the EFSF and the European Stability Mechanism, another pan-eurozone bailout fund, at triple-A. However, the outlook for both is negative and analysts have speculated that France's downgrade could lead Moody's to also demote the two funds. When Standard & Poor's, the rating agency, downgraded France in January it took three days before it cut its rating on the EFSF, Ciaran O'Hagan, a strategist at Société Générale, said in a note. "We will assess the impact of the downgrade [on other related entities like the EFSF/ESM] as a matter of course," Dietmar Hornung, senior credit officer at Moody's, told the Financial Times. Nonetheless, the bond sale delay did not unduly perturb investors. Although the EFSF's benchmark 10-year bond yield gained 5 basis points to trade at 1.92 per cent, the move was in line with the broader market. The EFSF was also able to raise €2bn in a six-month bill auction. "The sovereign uplift is still intact and the underlying quality of the French banks is not too bad," he says. Crédit Agricole and Société Générale appear to be doing a decent job of getting their house in order and scaling back their risks . . . [and] BNP Paribas is a better credit anyway. Nonetheless, the downgrade could have a negative impact on France, and underscores the longer-term concerns of many investors and analysts. One of the main reasons why French bond yields have continued to plumb new lows this year is heavy buying by overseas central banks, particularly Asian ones and the Swiss National Bank. Geoffrey Kendrick, a strategist at Nomura, estimates that the SNB now holds €48.1bn of French government debt. The downgrade could weaken the support offered by central banks. These typically favour the best-rated debt, but Standard & Poor's also stripped France of its top rating early this year. Successive downgrades could have a marked impact on central bank reserve portfolios. For example, the Moody's downgrade lowers the proportion of triple-A average debt held by the SNB from 86 per cent to about 70 per cent, Mr Kendrick estimates. "At the very least, [the] Moody's action is likely to mean the SNB stops buying French debt from here on," he says in a note. The impact is unlikely to be severe, however. Central banks, and many other investors, may have little option but to continue to buy French debt, quite simply because of the €1.3tn size of the market and the fact that it still offers at least some returns. In the eurozone only the German and Italian bond markets can rival France's size. But the former boasts negative short-term yields, and the latter is still a "no-go" area for many safety-conscious investors. "France is the only liquid and better-value core bond market left in Europe," says Christopher Marks, global head of debt capital markets at BNP Paribas. France benefits just out of its relative presence. But the Moody's move is a reminder that France's longer term economic and fiscal outlook is weak. "The cost of funding is low for France, but we see risks here in the medium term," Dietmar Hornung, senior credit officer at Moody's, says. Either we get an intensification of the crisis, in which case spreads are likely to rise, or we see a normalisation of yields, in which case funding costs also rise. Although Mr Moscovici blamed the last centre-right government for the downgrade - saying it was a "sanction on the past" - there has been scepticism among investors and economists over France's recently introduced reform package. Gilles Moec, European economist at Deutsche Bank, says the main challenge is to "re-engineer" the country away from domestic demand and into a more competitive, export-oriented economy. "That transition is going to be tough," he says.