THE TAKEAWAY: Moody’s Downgrades France -> Euro-area perceived financial stability decline -> Euro drops as crisis fight looks less manageable

The impact of regional financial and economic strain is starting to show through in the core economies of the Eurozone. The region’s second largest economy, France, was downgraded by the credit ratings agency Moody’s after the New York close.

Having had its benchmark rating lowered from Aaa to Aa1, yet another country has fallen from the top tier of the sovereign credit ratings group. In fact, with France off the list of countries with a top credit rating, that only leaves 16 for Moody’s listings.

In addition to the downgrade, Moody’s stated that the country’s long-term growth outlook is facing structural challenges and the outlook is murky with economics prospects deterioration. Further, the group says a sustained loss of competitiveness, rigidity in labor markets and uncertain fiscal outlook diminish France’s resilience to further shocks.

For the euro, this downgrade leaves Germany as the only top four Euro-area economy with a top credit rating (Austria, Finland, Luxembourg and Netherlands are the only other members of the shared currency that also retain the prime rating). This is important as the collective’s ability to fight the crisis between bloated deficits and fading growth depends on the perception that its rescue programs (EFSF, ESM, etc) are definitively durable. That strength is further cast into doubt by this downgrade. If Germany starts to feel ratings pressure, it could mark a serious turning point in the broader market’s confidence in the Eurozone.

Market Reactions

The risk that the Eurozone’s financial crisis fight has run into further trouble led to a quick reaction by euro traders. EURUSD dropped 50 pips quickly after the release and EURGBP (less sensitive to basic risk appetite trends) dropped 25 pips shortly after the report.

Forex_EURUSD_Drops_After_Moodys_Downgrades_France_body_Picture_5.png, Forex: EUR/USD Drops After Moody's Downgrades FranceForex_EURUSD_Drops_After_Moodys_Downgrades_France_body_Picture_6.png, Forex: EUR/USD Drops After Moody's Downgrades France

This drop is significant as it pulls both pairs away from their respective resistance ahead of another serious fundamental event risk: the EU’s decision on whether to award Greece its next round of financial aid to prevent a messy financial default. With the market expecting a positive outcome for the Greece ruling Tuesday morning, EURUSD traders will keep their gaze firmly affixed to the well-worn 1.2825 resistance level while EURGBP faces the 200-day moving average at 0.8075.

--- Written by: John Kicklighter, Chief Strategist for DailyFX.com

To contact John, email jkicklighter@dailyfx.com. Follow me on twitter at http://www.twitter.com/JohnKicklighter

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