Credit rating agency Standard & Poor's has fired a second warning shot at the Eurozone in 24 hours, threatening to cut the rating of its bailout fund as European leaders raced to find a political solution to their sovereign debt crisis.
German Chancellor Angela Merkel and French President Nicolas Sarkozy want to change EU rules to impose mandatory penalties on euro zone states that exceed deficit targets, aiming to restore market trust and prevent the crisis spiralling out of control.
Visiting US Treasury Secretary Timothy Geithner said after talks in Berlin he was encouraged by recent moves towards fiscal union in Europe and stressed the central role of the European Central Bank (ECB) in tackling the crisis.
Citing "continuing disagreements among European policy makers on how to tackle the immediate market confidence crisis", S&P put the ratings of 15 countries, including Germany and France, on review late on Monday for a downgrade by 1-2 notches.
The agency has now placed the top-notch rating of the Eurozone's €440bn (£378bn) rescue fund, the European Financial Stability Facility (EFSF), on negative watch since it depends on the creditworthiness of the currency bloc's six AAA-rated sovereigns.
European Council President Herman Van Rompuy, who will chair a crucial summit of the 27-nation European Union this week aimed at turning the corner on the crisis, proposed giving a bigger permanent Eurozone rescue mechanism the status of a bank that would allow it to access ECB funding.
Germany has so far opposed any such move, which it says would breach a treaty ban on the ECB financing governments.
Van Rompuy said tighter budget oversight sought by Paris and Berlin for the 17-nation euro area could be achieved quickly with only minor tweaks to the EU treaty that might not require full ratification procedures in many countries.
"To restore market confidence in the euro area, and to ensure the political sustainability of solidarity mechanisms, it is crucial to enhance the credibility of our budget rules (deficit and debt levels) and to ensure full compliance," he wrote in a report to EU leaders obtained by Reuters.
He also said the issuance of joint Eurozone bonds should be a long-term objective, challenging another German red line in a text likely to be the object of heated negotiations.
City A.M. Reporter