Nicolas Sarkozy pledges drastic austerity measures as French bank shares crash

Mr Sarkozy returned from the Riviera to chair an emergency meeting in Paris with his inner cabinet and the central bank chief, Christian Noyer, breaking the sacrosanct August holiday.

The key ministries were given one week to draw up radical austerity measures.

"Whatever the impact of global uncertainty, or the S&P's downgrade of America's debt, or the turbulence of the markets, we will take the necessary steps, " said finance minister François Baroin.

The political drama came as swirling rumours set off a collapse of French bank shares.

Société Générale fell 21pc before recovering partially, plagued by fears that it may be heavily exposed to tumbling global stockmarkets through its role in the equity derivatives market. Credit Agricole closed down 13pc, and BNP Paribas fell 10pc.

French banks have €410bn (£360bn) of exposure to Italy alone according to the Bank for International Settlements. The twin crises in France and Italy are now intimately linked and appear to be feeding on each other.

The MIB index on the Milan bourse fell 6.7pc as the euphoria following the European Central Bank's intervention in the Italian bond markets gave way to angst that the EU bailout machinery may not be large enough to back stop the whole of southern Europe.

France's CAC 40 closed down 5.5pc.

Morgan Stanley said the flight from French bank equities was "overdone".

BNP Paribas does not need to tap the capital markets this year, while SocGen is 93pc funded. The European Central Bank has kept its lending window open and offered a 6-month tender.

Julian Callow from Barclays Capital said the credibility of the €440bn rescue fund (EFSF) depends on France retaining its AAA rating.

That is now highly questionable despite assurances from all three rating agencies on Wednesday that nothing had changed.

"The debt ratios of the US and France are very similar. France also suffers from economic rigidities and now has this extra burden of the EFSF. People are asking themselves whether S&P can downgrade US without downgrading France," he said.

Mr Callow said France has a current account deficit of 3pc of GDP, unlike other members of the eurozone core. This is a sign of slipping competitiveness and a warning that France may struggle to carry the burden of escalating bail-outs.

French industrial output fell by 1.6pc in June and economic growth ground to a halt in the second quarter, further eroding budget finances.

The fiscal deficit was running at 7pc of GDP in the first half. It will take draconian cuts at this point to meet the 5.7pc target agreed with the EU.

With Spain, Britain, and even Italy now forcing the pace on austerity, France cannot appear nonchalant. Italy's premier Silvio Berlusconi met union leaders on Wednesay to forge a deal on €20bn of anti-deficit measures and labour reforms demanded by the ECB.

He has recalled parliament to vote on a balanced budget amendment to the constitution.

The ratings agencies are under intense pressure in Europe and may no longer be able to carry out their work effectively. Italian prosecutors have raided the offices of S&P and Moody's in Milan, accusing them of issuing "false and unfounded judgements" on the Italian financial system.

S&P said the accusations are "without any merit"

The Procura di Trani said the agencies had jumped the gun by issuing a report in early July on draft budget proposals.

Three analysts from S&P are accused of "market manipulation" and "abuse of privileged information" by issuing "inaccurate" reports over a period of several months.

This sort of judicial action against rating agencies is highly unusual. If it is shown in any way that the charges are politically motivated, the episode may inflict damage to Italy's reputation as a safe place to conduct business.

Marchel Alexandrivich from Jefferies Fixed Income said investors are worried that the latest contagion to France could bring the eurozone's bubbling problems to a head in a dramatic fashion.

"If France is dragged into the problem, then we will hit crisis point. They will either have to move to a full-blown eurobond -- and German politicians are set against that -- or face a break-up. There is a significant chance that the euro will no longer exist in its current form within twelve months," he said.

President Sarkozy said France would include a "golden rule" in its constitution to restore fiscal probity, adding that the fiscal targets for 2011 and 2012 were "untouchable".

The new budget measures will be introduced on August 24 and are expected to include the closure of 500 tax loopholes, .

The IMF said France has the highest debt ratio of any AAA state this year at 85pc of GDP and may have to tighten further next year. Like the US, France has also built up huge pension debt and contingent liabilities.

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Spain grits teeth yet again as austerity deepens

The conservative leader pledged to fight Spain's unemployment curse by shaking up the labour markets. The jobless rate has hit 22.8pc with 5.4m people out of work. The tally is certain to rise further as the economy falls back into recession.

Spain's 10-year bond yields dropped to 5.09pc, far below the 6.5pc stress peak seen last month, even though Mr Rajoy said the government will miss its budget deficit target of 6pc of GDP this year.

Global funds are gobbling up Spanish and Italian debt on bets that lenders will exploit the European Central Bank's offer of three-year credit at 1pc to buy sovereign debt, playing the "carry trade" on the yield spread.

Mr Rajoy evoked the triumph of the mid-1990s when Spain clawed its way back to viability and astonished EU officials by meeting EMU entry terms. But the path was smoothed by a peseta devaluation of 45pc over the preceeding three years.

It may prove harder this time within the euro straight-jacket. "The global economy was much stronger then and they benefitted from devaluation," said Dario Perkins from Lombard Street Research.

"Europe is repeating the same disastrous policy tried in Greece. They have not learned the lesson and it is hard to see how the outcome can be much better in Spain. The banking debts have been hidden and we don't yet know how much this will cost the government."

Mr Rajoy warned of further bank rescues as lenders struggle with €176bn in "troubled" assets. "A second wave of restructuring is inevitable," he said.

The fiscal cuts for 2012 will amount to 1.6pc of GDP, though details are scant. It follows earlier cuts of 1pc in May. Early retirement has been ended. Even saints days have been culled, shifting the holiday to Mondays to end the "bridge" of long weekends.

The package came as Standard & Poor's downgraded the region of Valencia to BBB- after it covered just 59pc of a bond issue. The agency said Valencia has "no clear access" to the capital markets. There is little risk of default on €1.6bn of maturing debt on Thursday, but S&P said the Junta is being kept afloat by money from Madrid.

Days earlier Fitch Ratings issued a downgrade warning for Spain and a clutch of EMU states and warned that a comprehensive solution to Europe's debt crisis may be "technically and politically beyond reach".

The agency said: "Of particular concern is the absence of a credible financial backstop. This requires more active and explicit commitment from the European Central Bank to mitigate the risk of self-fulfilling liquidity crises for potentially illiquid but solvent euro area member states."

The Bank of Spain said bad loans had reached a 17-year high of 7.4pc in October as the damge continues to filter through from the housing crash. The Madrid property consultants RR de Acuna predicts that prices will have to fall another 20pc before the market clears an overhang of one million homes.

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The volatility index hits three-month high as markets waiting for austerity vote

An increase in volatility index indicates a drop in appetite for more risky active such actions. Photo: AFP/GETTY IMAGESBy Rachel Cooper and agencies11: 33 AM BST 27 June 2011

In the persistent concerns that the Greece could by default, the Euro Stoxx 50 volatility index, which is considered a gauge fear market - pink 4 8pc to a maximum of three months fresh Monday.

An increase in volatility index indicates a drop in appetite for more risky active such actions.

The index of volatility VDXAX-NEW pink 4 9pc, while the volatility of the FTSE 100 index climbed 2 8pc.

Their rise came as traders exercised caution before the decision this week by the Greek Parliament on austerity measures unpopular.

Responsible debt country's Parliament will begin Monday a debate in three days on a package of measures aimed at increasing taxes and reducing spending

Without the approval of the package, the European Union and the Monetary Fund International say that they will not publish the fifth tranche of bailout package of €110bn Greece.

Nerves ahead of the established vote Greek bonds under pressure, the Greek bond yields difference of 10 years and German bunds expand on Monday morning.

The Greek and the Germany of 10 years spread 20 points of bais expanded agenda 1,432 basis points.

The debt of other very indebted countries also as cosine and the spread of performance 10 years Italian/German fluctuated around its highest level since the creation of the euro, approximately 218 basis points.

Despite the nerves, London equities have managed to recover some of their composure - with the FTSE 100 index, passing 21 points at 5718.

Last week, the FTSE 100 chalked a weekly loss of 0 3pc, marking the loss fifth weekly reference index; the last time he fell for several weeks has been consecutively in May 2008, when she refused for eight weeks.

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UK austerity plan averted gilts crisis, says debt management chief

 Mr Stheeman said the Chancellor's plans for a declining deficit have "clearly given markets a lot of reassurance over the last months". Photo: PA

Robert Stheeman, head of the UK Debt Management Office, said the picture has brightened so much over the last year that gilts have benefited from "safe-haven flows".

"The trajectory of the declining deficit and financing requirement over the next years has clearly given markets a lot of reassurance over the last months," he told a Euromoney bond conference in London. "We were on negative watch by Standard & Poor's and we are no longer on negative watch."

Mr Stheeman said the average maturity of the UK public debt is 13.5 years, by far the longest in the OECD club. "The fact that we have this undoubtedly helped us," he said.

Mr Stheeman was careful not to take sides on the bitter dispute between the Coalition and Labour over the pace of fiscal tightening.

Ed Balls, the Shadow Chancellor, has accused the Government of repeating the "mistake" of Margaret Thatcher's austerity policies after the 1979 oil shock, draining £13bn with a VAT rise just as the economy gasps for air.

However, it is clear that Britain was close to the precipice in early 2010, when investors feared political paralysis. Bill Gross, head of the bond fund PIMCO, said gilts were "resting on a bed of nitroglycerine."

Mr Stheeman said it was too early to sound the all clear. "I would not want to give the impression of complacency. We are conscious that we still have to issue very large sums of debt compared to a few years ago."

Separately, it emerged yesterday that the $237bn PIMCO Total Return fund had cut its holdings of US government-related debt to zero for the first time since early 2008, highlighting investor expectations of rising interest rates.

The move follows warnings by Mr Gross that bond yields were set to rise as the US Federal Reserve comes towards the end of its quantitative easing programme.

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