In Germany - whose top AAA rating survived unscathed - Chancellor Angela Merkel said the downgrades underlined why a so-called 'fiscal compact' must be signed by Member States quickly, and the next bailout mechanism, known as the ESM, should be funded soon.
"We are now challenged to implement the fiscal compact even quicker ... and to do it resolutely, not to try to soften it", she said at a meeting of her conservative Christian Democrats (CDU) in the northern city of Kiel. "We will also work particularly to implement the permanent stability mechanism, the ESM, so soon as possible -- this is important regarding investor trust", she added.
Leaders including Merkel have urged countries to tighten their belts with higher taxes and deep spending cuts to rein in massive budget deficits. But that has heightened market concern about their ability to grow their way back to health, pushing borrowing costs even higher for heavily indebted governments.
ECB policymaker, Ewald Nowotny, said Italy in particular would now face problems given large refinancing needs this year in that country and its banks. "...in my view this sharp downgrade of Italy is probably one of the most difficult and problematic aspects of this sweeping blow from the ratings agency."
European leaders are set to meet at a summit on January 30 to discuss how to boost growth and jobs, and Merkel's words on Saturday suggest she will also be looking for faster progress on tighter common fiscal rules. But now, policymakers at the meeting may have bigger fish to fry. The downgrades threaten the top rating of Europe's current bailout fund -- the European Financial Stability Facility -- as contributors France and Austria are no longer rated AAA. A downgrade of the EFSF could increase its borrowing costs, reducing its ability to protect the currency bloc's weaker members. S&P said it would deliver its view on the impact to the EFSF from the sovereign downgrades "shortly".
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