French borrowing costs defy downgrade in new fall

PARIS Thu Dec 6, 2012 11:42am EST

PARIS (Reuters) - France's long-term borrowing costs hit a record low at an auction on Thursday as investors favored the relative safety of French paper despite last month's Moody's downgrade and concerns over flagging competitiveness.

As with the United States, France's loss of its triple-A rating is proving no obstacle to investors keen to hold highly liquid bonds that yield more than their German counterparts.

France's debt management agency, Agence France Tresor, reported strong demand at the first long-term debt auction since November's one-notch downgrade, with three times as many bids as bonds sold.

The rally in French bonds comes despite widespread doubts over whether President Francois Hollande's government will be able to keep its deficit-cutting promises next year, as France's 2-trillion-euro economy remains in the doldrums.

With data on Thursday showing unemployment hit a 13-year high of 10.3 percent in the third quarter, low borrowing costs are a rare piece of good news for Hollande.

"French debt has remained relatively solid versus its EMU (euro zone) peers despite ... the downgrade by Moody's and risks for economic activity heading into 2013," Newedge Strategy market economist Annalisa Piazza said.

Investors snapped up the 6-, 7- and 15-year bonds at lower yields than the last time they were auctioned with the longest-term bond being sold at an all-time low of only 2.56 percent.

Though the national debt is flirting with an unprecedented 90 percent of output, France has been borrowing at record lows as investors seek the safety and liquidity of its large market.

The benchmark 10-year bond fell just below 2 percent on Wednesday for the first time despite Moody's downgrade, which followed a similar move by Standard and Poor's at the beginning of the year.

France has sold short-term debt at negative yields this year, meaning investors are paying to park cash in French bills. The premium investors demand to hold its long-term bonds instead of their German equivalents has also eased to about 68 basis points from about 74 prior to Moody's decision.

"It's quite incomprehensible that the spread between French and German debt is so tight given the diverging paths of the two countries," said Allianz Global Investors' head of European bond investments, Franck Dixmier. "We've been wrong on France."

Though wary of French debt, Allianz Global Investors is the second-biggest private institutional holder of French government bonds, according to filings tracked by Thomson Reuters.

DOWNGRADES OVER-RATED

After the United States lost its AAA rating with Standard and Poor's last year, France's fall from grace with the ratings agency has left the pool of big top-rated issuers restricted to a handful of countries including Britain and Germany.

Judging by the rallies U.S. and French bonds have seen despite their downgrades, the loss of AAA-status is not the drama it once was for countries. Yet British finance minister George Osborne pledged on Wednesday to extend austerity for another year partly to protect Britain's triple-A rating.

Falling French yields come despite concerns over France's failure to reform its economy and make it more competitive.

British magazine The Economist sought to capture those concerns in an article last month depicting the country as a "time-bomb at the heart of Europe".

French debt, about 50 percent of which is regularly bought by central banks and sovereign wealth funds, has benefited from record buying from Asia and the Middle East.

"Although we suspect France will not be a strong performer amongst the EMU core countries in 2013, we would not be too pessimistic as 2012 was a relatively good year for the French debt despite all the negative news," Piazza said.

Determined to forge its fiscal credibility, Hollande's government aims to carry out an unprecedented belt-tightening next year and cut the public deficit to 3 percent of national output from an estimated 4.5 percent in 2012.

However, many economists say that growth will fall short of the government forecast of 0.8 percent next year, putting the deficit target out of reach - an outcome analysts say the market has already largely priced in.

"France has no chance of respecting its pledge to bring the public deficit down to 3 percent of GDP since the growth forecast is not credible," Dixmier said.

(Additional reporting by Alexandria Sage, Marc Joanny and Emelia Sithole-Matarise in London; editing by Ron Askew)

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