Should Paris be forced into a heavy intervention to prop up its banking system, the price tag could cost France its cherished AAA debt rating. That rating would also be in jeopardy should Europe move to dramatically boost the size of its rescue fund to help Italy. The price tag for France — Europe’s second-largest economy — could shake its solvency.
“Fundamentally, it’s Germany and France that are underwriting the euro zone,” said Gavan Nolan, a research analyst at Markit Group in London, “but France is in a much weaker position than Germany, and rumors are rife that it will lose its AAA credit rating.”
In late afternoon trading, France’s CAC stock index had dropped 1.2 percent; Spain’s IBEX was down 1.05 percent; Europe’s Stoxx was down 0.59 percent, and Germany’s DAX up 0.16 percent.
At the same time, in Italy, the honeymoon for Mario Monti, an economist who became the country’s premier designate on Sunday, was quickly ending. Monti was holding intense meetings with Italy’s notoriously divided political parties on Tuesday to win backing for a new cabinet. But after an initial recovery in Italian bonds, investors again drove Italy’s borrowing rates above the unsustainable 7 percent mark.
Monti on Tuesday was winning key support from the People of Liberty Party of Silvio Berlusconi, Italy’s longtime playboy prime minister who stepped down on Saturday. With that backing, Monti he could win backing for a new government of technical experts later this week.
But even if he does quickly establish a working government, Monti would still need support in the coming weeks to force through a package of politically unpopular economic reforms aimed at jump-starting Italy’s moribund economy.
“Clearly there is a market deterioration in Europe overall,” said Tito Boeri, an economist at Bocconi University in Milan. “Now, they are testing France, too. But in Italy, the task ahead is very difficult. Today, Monti managed to get more political support. But the key issue is still making sure the reforms can go through.”
Spain’s borrowing costs also spiked on Tuesday ahead of elections on Sunday that could speed economic reforms there. Spain did not raise its maximum target in an auction of 12-month bonds.
Those bonds yielded 5 percent on average, far higher than the 3.6 percent levels a month ago. Although countries can withstand a period of higher borrowing costs, trouble can come quickly if they have difficulty lining up any lenders. Spain will try to sell 10-year bonds on Thursday and may have to borrow at rates close to record highs in the euro era.
The leader that Spain chooses on Sunday will likely sweep in new reforms, analysts said, especially if the conservative People’s Party wins the absolute majority that polls predict. Unlike Greece and Italy’s new leaders, the Spanish government will have a popular mandate for its changes.
“In Spain you don’t have a sense that markets have twisted your arm,” despite the rising borrowing costs, said Jose Ignacio Torreblanca, who runs the Madrid office of the European Council on Foreign Relations.
In Germany on Tuesday, Chancellor Angela Merkel’s Christian Democrats were ending a party conference in which they agreed to try to make it easier for countries to leave the euro, sending further currents of worry through the markets.
Until earlier this month, euro zone leaders had treated the currency as sacrosanct. That ended when Merkel and French President Nicolas Sarkozy suggested that Greece would leave the euro if it rejected a European bailout plan. At the conference, Merkel’s party approved a goal to allow countries to leave the currency voluntarily without leaving the European Union.
In a speech, German finance minister Wolfgang Schaeuble warned of the potential consequences if the debt problems keep escalating.
“If Italy were to be in the same camp as Greece, we wouldn’t be able to hold on to the euro,” Schaeuble said. But he added that he did not think Italy would need to resort to Europe’s bailout fund.
Staff writer Michael Birnbaum reported from Berlin. Special correspondent Karla Adam contributed to this report from London.