Eurozone crisis: the key questions answered

What does the downgrade mean for Europe – and Britain?
Standard & Poor's offices
Standard & Poor's downgraded nine eurozone countries on Friday. Photograph: Justin Lane/EPA

What is S&P?

Standard & Poor's is the oldest of the big credit ratings agencies. It assigns grades – credit ratings – to countries, institutions and companies that need to borrow money, to help lenders gauge the risk they are taking. Essentially, the lower the rating from a ratings agency, the higher the interest a borrower has to pay to compensate for the possibility of it defaulting.

What has S&P done?

It has cut the credit ratings on nine countries in the eurozone. The most high-profile casualties were France and Austria, which lost their prized AAA ratings – the top grade, held by only 14 countries worldwide, among them the UK. Sharp downgrades to Cyprus and Portugal left them with "junk" ratings on their debt – ranking them as very risky investments.

A handful of countries escaped Friday the 13th unscathed, notably Germany, which S&P said had a track record of "prudent fiscal policies and expenditure discipline".

What is S&P worried about?

Essentially, it thinks eurozone policymakers have not done enough to resolve the region's "broadening and deepening financial crisis". It criticised the latest talks as failing to come up with "a breakthrough of sufficient size and scope to fully address the eurozone's financial problems".

Importantly, S&P stresses that governments have been wrong to focus on austerity measures alone because these can become "self-defeating". It warns the ensuing worries about jobs and household incomes would damage domestic demand and consequently national tax revenues.

How vulnerable is the UK to a downgrade?

For now, Britain retains its AAA rating, but policymakers in France and Germany are already pointing the finger at the UK, saying its relatively high debt and flagging growth make it equally, if not more, deserving of a downgrade.

But economic indicators and debt levels are not the only factors ratings agencies take into account. In making the call on how likely a country is to be able to repay its debts, whether a country is in the euro or not plays a big role. Unlike eurozone members, Britain should not be forced to bail out struggling European nations, and, more importantly, it still has monetary autonomy – the Bank of England can (and has) start printing money to shore up the economy. Finally, ratings agencies look at how soon, and at what rate, countries must repay their debts. France has to come up with around £100bn this year, but the UK has to find only around half that.

What difference do the downgrades make?

For those downgraded, the cuts are likely to result in higher interest being demanded when countries want to borrow. Governments need to auction bonds to pay for state spending and to cover the cost of repaying older bonds that are maturing (known as "rolling over" debt). Auctions from crisis-stricken Spain and Italy last week enjoyed a significant fall in rates, but those are likely to go up again now. In Italy, the cost of borrowing keeps pushing through the 7% barrier, which is regarded as unsustainably high. When a country cannot afford even to service its debts, it becomes increasingly likely to require a bailout.

Does this make bailouts harder to fund?

Yes. The eurozone's rescue fund, the European financial stability facility (EFSF), uses guarantees from its member countries to raise funds in financial markets. If those backer countries are seen as less creditworthy, so is the fund – and it could well be downgraded too. That will make it more difficult and more expensive to raise money from financial markets and other countries outside the eurozone. The fund has already committed large sums to Greece, Ireland and Portugal and will need to raise more money should Italy and Spain need the same kind of help.

What happens next?

S&P has given nearly all the countries it downgraded a "negative outlook", meaning there is a one in three chance of a further cut in 2012 or 2013. It says refinancing costs for some countries will stay high, credit will be hard to come by and growth will slow.

The rising borrowing costs that many countries will face in the wake of these downgrades will have repercussions across the eurozone. There are worries, for example, that rising borrowing costs for Italy mean it will sooner or later need to apply for help from the EFSF. If it does – and drops out of the fund as a backer – there are serious implications for key guarantors Germany and France. Their obligations to the rescue fund would rise – and put fresh pressure on their credit ratings.

• The following correction was published on 5 February 2012:
"Downgrades, debt and junk: key questions about the eurozone crisis answered" (Business), said: "The [Eurozone financial stability facility] fund has already committed large sums to Greece, Ireland and Portugal and will need to raise more money should Italy and Spain need the same kind of help." However, the €110bn bailout to Greece of 2010 was not part of the EFSF guarantees and not managed by the EFSF.

Today's best video

Today in pictures