Is the EFSF next in line for downgrade?

Fidelity Worldwide Investment’s group chief investment officer has warned the European Financial Stability Facility (EFSF) is next in line to be downgraded by ratings agencies.

Dominic Rossi said speculation around the EFSF's credit rating will intensify following the raft of downgrades dished out by Standard & Poor's at the end of last week.

Rossi (pictured) said the downgrades of France and Austria - which both lost their prized AAA-ratings - casts doubt over the creditworthiness of the EFSF.

"While the downgrade to France may not be too surprising to markets, it is still disappointing news that will drag down the euro and equity markets," said Rossi.

"Speculation around an EFSF downgrade will now grow, complicating its ability to raise capital and displace the ECB in the sovereign bond purchasing programme."

He said there was also a risk the ECB and the IMF will get called on to do more to help the EU.

Rossi's view was echoed by M&G bond manager Mike Riddell who said the EFSF faces the possibility of being downgraded if credit spreads continue to widen.

"A French downgrade would be particularly problematic to the European leaders who still seem to believe the EFSF is a tenable solution to the eurozone debt crisis, since the EFSF structure needs AAA-rated guarantors," said Riddell.

He said the move to cut France's AAA-rating was justified as spreads had widened to significant levels compared to German bunds, particularly since the start of the year.

"Perhaps more worrying than the poor performance of EFSF bonds is the dire performance of French government bonds, particularly in the last couple of weeks," said Riddell.

"French spread widening poses a major problem because the tail tends to wag the dog when it comes to credit ratings.

"Widening spreads tend to cause credit rating downgrades, which tend to cause further spread widening."

Markets were muted in early trading, with no major sell-offs seen. Old Mutual Asset Managers' Kevin Lilley, manager of the group's £61m European Equity fund, said this was because the downgrade was priced in.

"The downgrades were no surprise and you can see they did not spook the market this morning as the bad news was already priced in," said Lilley.

"Germany are the big winners out of all of this, being the only AAA-rated country with a stable outlook. But they need to share their wealth with the rest of the eurozone and be more accountable in order to enhance the GDP for the whole of the continent."