France, the euro zone’s second-largest economy, retains a top-notch AAA bond rating and is able to borrow at rates substantially below those for Spain, Italy and other economically weaker countries. But the widening of the interest rate spread between French and German bonds is a significant sign that investors may no longer view France as a haven.
The emergency plans that European leaders recently developed in response to the debt crisis hinge on France keeping a strong credit rating. Any hint that France might lose that status could intensify the region’s crisis and leave Germany as the sole, large underwriter of any rescue effort.
“Clearly there is a market deterioration in Europe overall,” said Tito Boeri, an economist at Bocconi University in Milan. “They are testing France, too.”
The rise in Spanish rates and continued high borrowing costs in Italy come despite what would otherwise be positive political developments.
In Spain, polls project that the conservative People’s Party will win an absolute majority in an election this weekend and take office with a popular mandate for the type of tough budgets and economic changes that many economists consider necessary to keep the country on track. Still, Spain’s sale of short-term, one-year bonds fell short of its target, and the interest rate jumped to 5 percent, compared with 3.6 percent in a similar sale last month.
In Italy, new Prime Minister Mario Monti appeared to be making progress in assembling a cabinet that would draw from all major political parties and ease the way toward major fiscal reforms.
“I am confident I will make it,” he said at a news conference.
Uncertainty about whether Monti would be able to quickly put together an effective government has unsettled financial markets in Europe and the United States. Rates on key Italian bonds remained above 7 percent Tuesday as analysts continued to doubt whether the country would be able to bring down its high level of public debt and force through dramatic economic changes.
Interest rates in Austria and Belgium have also been rising relative to those of Germany, and there are increasing signs that key Eastern European economies such as Poland and Hungary are beginning to feel the impact of Western Europe’s problems.
As a backdrop to the debt debate, the Eurostat statistics agency released new data showing that the 17-nation euro area remains mired in slow growth, expanding only 0.2 percent over the past three months.
“Economic activity across the Eurozone has faltered substantially,” Howard Archer, chief European economist for the consulting firm IHS Global Insight, wrote in an analysis. Growth in Germany and France rebounded slightly, he said, “but this looks highly unlikely to be sustained.”
Slowing growth forced French President Nicolas Sarkozy to propose a further round of budget cuts to keep the country within its current deficit targets — important in the drive to maintain a top credit rating.
But the developing slowdown may make for a difficult road ahead.
France, for example, depends heavily on trade with its euro region neighbors. If the economies of Italy and Spain falter, as many analysts expect, France won’t be far behind, said Dominic White, European economist at London-based Absolute Strategy Research.
About a fifth of France’s exports go to Europe’s heavily indebted southern tier of countries and about half to the euro zone overall, while Germany has been more successful in exporting to the rest of the world.
“France is caught in the middle,” White said. “It has some strong companies that look a little more Germanic. It also has a large part of its economy that looks a lot like the south.”
Vincenzo Visco, a two-time former Italian finance minister, said the still-high Italian borrowing rates and the spread of concerns to France underscored the need for Europe to cease using half-measures to resolve the crisis and take more drastic action. He said nations in the euro zone must rally around the idea of the European Central Bank embarking on a far larger effort to buy up the troubled bonds of European governments, effectively embracing the kind of large-scale bond purchases that the Federal Reserve undertook to combat the U.S. financial crisis.
“The risk of collapse in the euro zone is now very high,” he said. “I think and I hope that the Germans and the French will understand just how difficult things now are and have the ECB do its job as lender of last resort. I don’t see any other solution.”
Faiola reported from Rome. Correspondent Michael Birnbaum in Berlin contributed to this report.