Germany escaped S&P’s scrutiny unharmed. It’s triple-A credit rating was left unchanged and given a stable outlook.

S&P’s steps were certain to make it more difficult for European leaders to solve the debt crisis and could trigger a period of volatility in financial markets similar to what investors experienced in the wake of S&P’s downgrade of the United States last year, said Jeremy Hare, Managing Director of Investments at Gilford Securities. S&P’s moves would also, Hare said, shine a harsh light on the leaders’ ineffectual efforts to solve the crisis.

“It hits them right on the chin,” Hare said. “S&P is calling (German Chancellor Angela) Merkel out and saying, ‘Hey, fix the problem’.”

S&P cut France, Austria, Malta, Slovakia and Slovenia by one notch, stripping France and Austria of rare triple-A ratings that were key to their ability to support efforts to rescue struggling euro zone members. The ratings agency also downgraded by two notches Italy, Spain, Portugal and Cyprus. Portugal and Cyprus were cut to junk status.

Of the countries mentioned in Friday’s statement, only Germany and Slovakia were given stable outlooks. The rest received negative outlooks, meaning S&P believes there is at least a one-in-three chance they may be downgraded in 2012 or 2013.

S&P said it was taking the actions because Europe’s leaders had failed at recent meetings to take decisive steps to solve the region’s debt crisis. It specifically noted that a Dec. 9 summit deal did not go far enough.

“The political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those euro zone sovereigns subjected to heightened market pressures,” S&P said in a statement.

S&P went further, casting doubt on Europe’s approach of insisting on tough austerity measures as the main path to restoring financial stability in Europe.

“We believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating,” the agency said.

Instead, it highlighted “rising external imbalances and divergences in competitiveness between the euro zone’s core and the so-called ‘periphery’” as a significant source of the bloc’s problems that needed to be addressed.

The news of S&P’s action was greeted with dismay by European leaders.

“This is not good news,” French Finance Minister Francois Baroin said in an appearance on French national television. Baroin called the downgrade “a semisurprise” and added that it was “not a catastrophe.”

Baroin, who spoke after a day of swirling rumors about an imminent downgrade of France, also said that France’s economic policies would not change as a result of the downgrade.

“It is not the rating agencies who dictate French policy,” he said.

European Commission Vice President Olli Rehn said the euro zone had taken decisive action to fix the crisis.

The central bank had unexpectedly hiked interest rates by 25 basis points at its June meeting. Before that, it had refrained from any action at the previous two meetings in April and May. It had hiked rates by 25 basis points from 2.75 percent in March.

"The committee considers major advanced economies to have remained sluggish, and growth in emerging market economies to have also slowed somewhat," the bank said in a statement accompanying the decision. "Going forward the Committee expects the pace of global economic recovery to be very moderate, and judges that the downside risks to growth are becoming larger, due mostly to the sovereign debt crisis in Europe and to the possibilities of the slumps in major country economies and the unrest in international financial markets continuing."

Analysts had widely expected no change even though consumer prices in December remained at 4.2 percent for the second straight month – keeping overall inflation above the central bank’s target range of 2 to 4 percent. November had marked the first time this year that CPI had fallen within the range.

On a monthly basis, CPI was up 0.4 percent. Core CPI, that excludes prices movements in food and energy, rose 3.6 percent year-on-year compared to a 3.5 percent gain in November.

However, producer price inflation in South Korea eased to 4.3 percent in December from 5.1 percent in November. On a monthly basis, the producer price index was up 0.2 percent compared to 0.2 percent fall in November. The index rose 6.1 percent for the year 2011 as a whole.

"Consumer price inflation continued to exceed 4 percent in December last year, driven by the prices of petroleum products and processed food, and core inflation also came in at a level similar to that of the previous month," the bank said. "In the coming months, factors including the base effect from the previous year and the easing of demand-side pressures will work in favor of price stability, but the Committee expects the pace of decline in the inflation rate to be moderate given factors such as ongoing high inflation expectations."

Before raising rates by 25 basis points last November to 2.50 percent, the bank had left rates unchanged since it unexpectedly raised rates by 25 basis points from the record low of 2.00 percent last July.

Before that, the rate had held steady for 16 straight months, after the bank had trimmed rates six times in the previous four months.

France’s finance minister just confirmed that the ratings agency is lowering the French credit rating by one notch.

In December, S&P put most of the single currency bloc on negative creditwatch, citing concerns about "deepening political, financial and monetary problems with the European economic and monetary union."

"There is talk now that Italy, Spain and Portugal will get a 2 notch downgrade. If so, Italy’s credit rating will be BBB+, two notches below Moody’s and 3 below Fitch. Spain’s would be A, one notch below Moody’s and two below Fitch," said Peter Boockvar, Managing Direct at Miller Tabak. "Portugal’s rating would go to BB, junk and that would put them in line with Moody’s and one notch below Fitch."

The news overshadowed a slew of economic data from the U.S., including a strong reading on consumer sentiment.

The dollar rose two cents to $1.2625 versus the euro, its highest since September 2010. A successful Italian debt auction gave the euro an early boost.

The buck hit an 18-month peak of $1.5232 versus the sterling, and edged up to C$1.0240 versus Canada’s loonie.

Consumer sentiment in the U.S. has seen a significant improvement in the month of January, according to a report released by Reuters and the University of Michigan on Friday, with the consumer sentiment index rising by much more than anticipated.

The report showed that the consumer sentiment index jumped to 74.0 in January from the final December reading of 69.9. Economists had been expecting the index to edge up to a reading of 71.5.

With prices for U.S. fuel imports pulling back in December after showing a sharp increase in the previous month, the Labor Department released a report on Friday showing a modest drop in overall import prices.

Export prices also fell during the month due in part to a notable decrease in prices for agricultural exports. The Labor Department said imports prices edged down by 0.1 percent in December after rising by an upwardly revised 0.8 percent in November.

Reversing a drop in October, the U.S. trade deficit saw a notable increase in November, according to figures released Friday by the Commerce Department. U.S. exports fell by 0.9 percent to a level of $177.8 billion, while imports rose by 1.3 percent to a level of $225.6 billion, according to the report.

That put the trade deficit at $47.8 billion, a 10.4 percent increase from October’s revised level of $43.3 billion.

France’s loss of its AAA-rating deals a heavy blow to the eurozone’s ability to fight off its debt crisis. The country is the second-largest contributor to the currency union’s bailout fund.

S&P in December put 15 eurozone countries on creditwatch and other downgrades were expected later Friday.

The cut in France’s creditworthiness could also hurt President Nicolas Sarkozy’s re-election chances.

Europe’s ability to fight off its debt crisis was again thrown into doubt Friday when the euro hit its lowest level in over a year and borrowing costs rose on expectations that the debt of several countries would be downgraded by rating agency Standard & Poor’s.

Stock markets in Europe and the U.S. plunged late Friday when reports of an imminent downgrade first appeared and the euro fell to a 17-month low.

The fears of a downgrade brought a sour end to a mildly encouraging week for Europe’s heavily indebted nations and were a stark reminder that the 17-country eurozone’s debt crisis is far from over.

Earlier Friday, Italy had capped a strong week for government debt auctions, seeing its borrowing costs drop for a second day in a row as it successfully raised as much as euro4.75 billion ($6.05 billion). Spain and Italy completed successful bond auctions on Thursday, and European Central Bank president Mario Draghi noted "tentative signs of stabilization" in the region’s economy.

A credit downgrade would escalate the threats to Europe’s fragile financial system, as the costs at which the affected countries — some of which are already struggling with heavy debt loads and low growth — could borrow money would be driven even higher.

The downgrade could drive up the cost of European government debt as investors demand more compensation for holding bonds deemed to be riskier than they had been. Higher borrowing costs would put more financial pressure on countries already contending with heavy debt burdens.

A Labor Department official said that seasonal adjustment factors were at play in the large decline. The models had expected a larger increase than actually took place.

The four-week average of new claims also fell, down 3,000 to 393,250. This is the lowest level since early April. The monthly average is seen as a more accurate gauge of labor trends because it reduces volatility in the week-to-week data.

Economists generally believe it’s a sign of faster job creation and stronger economic growth when claims fall below the 400,000 threshold. Although the claims data directly reflects people who lose their jobs, the number of claims declines when hiring outpaces layoffs.

Since late April claims have gradually fallen from a 2011 high of 478,000 to around the 400,000 mark.

Earlier in the week, comments by ECB President Mario Draghi were thought to foreshadowed further asset purchases on the condition that political leaders agree to a central fiscal authority and spending discipline.

With EU officials arriving in Brussels to discuss the issue, Draghi made clear that his comments were not meant as a promise of more quantitative easing.

Instead, the ECB lowered interest rates by a modest quarter percent to one percent, and unveiled added liquidity measures in support of the banking system.

For the first time ever, the ECB will conduct two longer-term refinancing operations with a maturity of 36 months and the option of early repayment after one year.

The move was not enough to please the markets, as stocks fell sharply around the world, raising risk aversion.

The dollar jumped to $1.33 versus the euro, up from $1.3450 in very early dealing. The dollar also gained on the sterling, improving to $1.5630 from near $1.58.

The Bank of England kept its key interest rate on hold at 0.5 percent this morning.

While the buck gained a penny to C$1.0220 versus its Canadian counterpart, and rebounded to Y77.75 from weekly lows against the yen.

By Chou Yung-chieh and Ann Chen CNA Nov. 22 2011

€ Spain’s People’s Party won an absolute majority in Sunday’s elections, taking 186 seats in the 350-seat lower house to unseat the Socialist government from power; Mariano Rajoy will not be sworn in as Prime Minister until mid-December although focus will shift immediately to his plans for greater austerity

EQ The S&P 500 traded in a narrow range and ended flat on the session at 1215.65 on Friday; down 3.8% on the week as concerns about spillover effects from the Eurozone crisis weighed on sentiment, overshadowing more signs this week of a pick-up in US economic activity in Q4; the Citigroup US economic surprise index rose to the highest levels since early-April; in Europe the major stock indices of Italy, Portugal and Spain rose slightly on Friday, but the broad Stoxx 600 lost 0.8% to bring the week’s decline to 3.7%

FI USTs fell on Friday but gained over the week as pessimism rose regarding European officials’ willingness to act quickly to stem contagion; the US 10yr yield rose 5bps on Friday to 2.010% but was down from 2.13% at the start of the week; Bunds declined as well on Friday and the 10yr cash yield rose 7bps to 1.962%; the Italian 10yr yield fell further, down 19bps to 6.631%, back to levels seen at the start of the week amid the ongoing ECB purchases of Italian and Spanish bonds according to reports; Spanish 10yr fell 11bps to 6.312% and French was down 17bps to 3.446%

FX The euro rose 0.4% on Friday to 1.351 and slightly pared the week’s loss to 1.9%

$ NY Fed President Dudley (voter): "growth has picked up modestly in the second half of 2011, but not enough to bring unemployment down”; strong headwinds are preventing a more vigorous recovery; the Fed will continue to do everything in its power to promote employment and price stability

$ Fed’ Fisher (voter): "Unless our politicians get their act together…the bond market will take their vengeance on us as well”; he sees inflation trending back down to 2%

$ Fed’s Williams (voter in 2012) does not expect the US economy to reach full employment until 2016; "Fiscal policy actions that reduce uncertainty and stimulate recovery are badly needed"

$ The US House voted down legislation on an amendment to the Constitution that would require the federal government to balance the budget; a 2/3 majority was required but the votes in favor were only 261 vs. 165 against

$ US index of leading indicators rose 0.9%MoM in October, exceeding the consensus forecast of +0.6%; the September gain was revised down to +0.1% (originally +0.2%); 9 of 10 indicators made a positive contribution in October; the 6-month annual change accelerated to a 3-month high of +6.1%, up from 3.5% previously

€ European officials reportedly may begin talks with the IMF about how the ECB could lend to the IMF so that broader sovereign support could be provided; talks could result in an announcement at the EU Summit on Dec. 9 – Dow Jones

€ ECB President Draghi regarding expansion and enhancement of EFSF: "Where is the implementation of these long-standing decisions?” he said the ECB could lose credibility very quickly which would have “huge” costs; downside risks to Euro area growth have increased; weaker growth will moderate inflation

€ ECB’s Weidmann: "The lack of success in containing the crisis does not justify overstretching the mandate of the central bank and making it responsible for solving the crisis… "a clear commitment to our mandate is an indispensable element of a prosperous future for the euro"

€ German FinMin Schaeuble said that if ECB unleashed its full firepower, which is not provided for legally, calm in financial markets would last for a few weeks at most

€ Italian PM Monti won the confidence vote in the Chamber of Deputies (556:61); he said that he supported the idea of euro bonds when he was an economist, but wants to discuss with German and French leaders before taking a stance as PM

£ UK PM Cameron said a credible firewall is needed for the Eurozone and that all institutions should stand behind the currency; the European Commission’s request for 5% increase in EU budget is not acceptable

€ German producer prices rose at a slower monthly pace of 0.2% in October from 0.3% in September although the gain was above consensus at +0.1%; the annual gain eased to 5.3% from 5.5%, down from the 2011 high of 6.4% reached in April

€ Italian industrial orders plunged 8.3%MoM in September in another sign the economy is in recession, the sharpest decline since Aug’09 and below the consensus forecast of -6.0%; the August gain was revised down to +4.2% (originally +5.0%); sales of industrial goods fell 5.4%MoM, the largest percentage decline since Nov’08

FI The ECB was in the market for Italian and Spanish debt, which helped pull 10yr yields down from new euro-era highs reached early in the session after Spain sold 10yr bonds at a sharply higher yield of 6.975%; the Italian 10yr fell 19bps over the session to 6.794%; the French 10yr yield moderated as well and ended the day down 7bps at 3.614%; Spanish still ended up 7bps at 6.421%; USTs chopped around but ended stronger, with the yield on the 10yr down 4bps to 1.960%, the lowest close since 5Oct; $ 3m Libor climbed further and jumped 0.8bps to 0.47944% on Thursday, the highest since Jul’10

FX EUR/USD moved higher after US jobless claims came in lower-than-expected, but pared gains by the US close to end flat at 1.347, remaining at the lowest level in more than a month; the yen outperformed on the session, up across the board versus major currencies – USD/JPY fell 0.1% to 77.00; Cable rose slightly to 1.576

$ NY Fed President Dudley (voter): "If additional asset purchases were deemed appropriate, it might make sense to do much of this in the mortgage-backed securities market"; the Fed is not out of ammunition

$ Fed’s Pianalto: "Our policy is appropriate in this economic environment…But in this economy, monetary policy alone cannot cure all of the economy’s ills”; she expects growth of 2.5% in 2012 and 3% in 2013

€ Spain sold €3.56bn in 10yr (Jan’22) bonds at 6.975%, just a few bps below 7% and a euro-era high; bid/cover was just 1.54; at a similar auction on 20Oct, Spain sold €1.8bn in Apr’21 bonds at an average yield of 5.433% with b/c at 1.76

€ France sold €7bn in fixed-rate bonds, the largest issue being $3.3bn in 2.5% 2016 notes, which priced with a yield of 2.82%, up from 1.80% at the previous similar auction on 15Sep

€ Eurozone officials and the IMF have reportedly discussed the possibility that the ECB could lend to the IMF which could then support Eurozone governments – Reuters

€ EFSF leveraging options have reportedly received positive feedback from Asian investors, who would be ready to participate if market confidence improves and volatility falls; there are no plans for Italy to access the EFSF – Reuters

€ German Chancellor Merkel again called for EU treaty changes and said that political solutions are needed to end the crisis; "if politicians think the ECB can solve the euro crisis, then they are mistaken”

€ German FinMin Schaeuble said there are signs that market contagion is having an effect on the real economy; banks must be shielded and officials should be vigilant that effects do not spread to the insurance sector

€ Italy PM Monti won a confidence vote in the Senate after he outlined his government’s plans; first steps are measures to confront the current crisis of confidence and ensure sustainability of public finances; then reforms to “modernize economic and social structures”

€ IIF head Dallara is encouraged about the prospects for a deal on Greek debt, but approval of a 2nd EU/IMF aid programme is crucial; he believes consensus can be reached to involve 70-80% of private holders of Greek debt; he does not envision a broad range of exchange options for creditors this time; if all goes smoothly, debt relief could begin in early January

$ US initial jobless claims fell for a 3rd consecutive week, to 388k in the week to 12Nov from an upwardly revised 393k in the week prior (originally 390k); claims were the lowest since early April and down 16k from a month ago; continuing claims fell 57k to 3.608m, the lowest level since mid-Sep’08

$ US Philly Fed manufacturing PMI fell to 3.6 in November from 8.7 in October but remained above the 3- and 6-month moving averages after the summer slump; the new orders and shipments balances fell from October but remained in positive territory at 1.3 and 7.3 respectively; the employment balance climbed to 12.0 from 1.4 previously and was the highest since May (22.1); the outlook for the next six months improved and was the strongest since March

$ US housing starts fell 0.3%MoM in October versus the median forecast of -7.3%, but the September gain was downwardly revised and chopped to +7.7% from +15.0%; thus the annualized pace of starts was little changed at 628k versus 630k in October (originally 658k)

€ Eurozone construction output fell 1.3%MoM in September, the largest decline so far this year, and the August figure was revised to -0.4% (originally +0.2%); however in Q3 as a whole, output was up 0.7% vs. +0.3% in Q2

£ UK retail sales rose again in October, confounding signals from the other survey measures of retail activity and the depressed levels of consumer confidence; sales rose 0.6% versus a downwardly revised gain of 0.5% in September (originally +0.6%); exceeding the consensus forecast of -0.3%; sales excluding auto fuel were up at a steady pace of 0.6%MoM; according to the Office of National Statistics, “feedback from retailers suggests that the monthly increase…was a result of pre-Christmas sales and in store promotions”

£ UK Nationwide consumer confidence dropped to 36 in October from 45 in September, a result below the consensus forecast of 43 and the lowest in the series history since May’04

FI Longer-end UST yields headed lower late in the session as sentiment deteriorated; the 10yr yield fell 5bps to 1.999% and the 30yr was down 6bps to 3.028%; Italian bonds stabilized as the ECB reportedly bought larger-than-usual quantities of Italian debt in the European session; the 10yr yield fell 6bps to 6.989% after Tuesday’s advance above 7%; Spanish and French bonds remained under pressure on Wednesday in the run up to today’s auctions; the Spanish 10yr yield rose 8bps to 6.349% and the French was up 2bps to 3.686%; the benchmark Bund future declined 56 ticks to 138.15; the UK 2yr gilt yield fell 1bp to 0.475% and short-sterling futures rose slightly out the curve as the BoE lowered their CPI projections and Gov. King said activity “could be broadly flat until around the middle of next year”

FX EUR/USD fell early on Wednesday to the lowest level in more than a month and ended the US session down 0.5% at 1.347; the dollar and yen outperformed on the session, while sterling fell broadly versus major currencies amid warnings about the economic outlook from the BoE and a rise in the UK unemployment rate; Cable fell below the 50dma, down 0.6% to 1.573 which was the weakest since 21Oct

OIL WTI Dec’11 crude jumped above $100bbl as Enbridge Inc. agreed to acquire a share of pipeline that runs between Cushing, OK and the Gulf and said they could reverse the flow of oil which may alleviate a bottleneck that had been depressing the price of WTI

$ Fed’s Lacker (voter in 2012) said the economy would be better served by Fed purchases of Treasuries than MBS; he supports an explicit inflation objective as the most important step the Fed could take to enhance transparency; banks have done a lot to prepare for potential fallout from the crisis in Europe but he is less confident about the money market funds

$ The NY Fed “informed its primary dealers today that it will require dealers to margin against their outstanding agency MBS forward transactions with the NY Fed. Dealers are required to post collateral in a number of other types of operations with the NY Fed" – Reuters

€ Portugal sold €1.1bn in 3- and 6-month bills within a target range of €0.75-1.25bn; the yield at the 3-month sale was lower at 4.895% versus 4.972% at the 19Oct sale; bid/cover stronger at 2.4 vs. 2.0 previously

€ Mario Monti was sworn in as Italy’s Prime Minister and unveiled a 16-member cabinet; he will act as Economy Minister as well; today he will present his reform plans to the Senate, after which a confidence vote is expected in both houses of parliament

€ Greek PM Papademos won a vote of confidence on Wednesday, gaining 255 votes in support of the national unity government out of 300; the PM will meet with the head of the IIF today to discuss the loss-plan for private bondholders; New Democracy party head Samaras remains opposed to signing a written agreement on meeting terms for the EU/IMF bailout

€ EC President Barroso said the crisis is now “truly systemic” and “requires an even stronger commitment from all and that may require additional and very important measures”; deeper integration, an economic union, is required; once complete, “stability bonds” will be a natural step; stronger integration is also needed within the entire EU

€ Chancellor Merkel said Germany is willing to "cede a bit of national sovereignty" to underpin the euro; treaty changes are needed

€ Irish PMKenny said there is an immediate need for a credible liquidity backstop; “ultimately that’s the ECB” although he acknowledged there were diverging views; the EFSF “has proven not to have the confidence of the markets”

£ UK BoE Inflation Report: the central projection for the UK CPI was lowered over the forecast horizon, despite the assumption of £275 in BoE asset purchases vs. £200bn previously and current expectations that Bank Rate will stay low-for-longer; the fan charts show the CPI at about 1.3%YoY in 2 year’s time, below the August 2yr-projection of 1.7% and further below the 2% target, which signals scope for more asset purchases; BoE Gov. King outlined weaker expectations for near-term UK economic growth than in the August Inflation Report and said activity “could be broadly flat until around the middle of next year”; by end-2012 growth is expected at about 2% vs. 2.2% in the August projections; the fan charts indicate greater chance of a recession over the next 18 months

$ US industrial production rose 0.7%MoM in October and exceeded the median forecast of +0.4%, although the September figure was revised down to -0.1% (originally +0.2%); manufacturing output rose for a fourth consecutive month, up 0.5% vs. +0.3% previously; vehicle production jumped 3.1% vs. 0.4% previously and ex-vehicle manufacturing was up at a steady pace of 0.3%

$ US NAHB index of homebuilders’ sentiment rose to 20 in November from a downwardly revised 17 in October (originally 18); the index was the highest since May’10

$ The US CPI fell 0.1%MoM in October versus a gain of 0.3% in September; the decline was the first since June and reflected a drop of 2.0% in energy prices and -0.4% for vehicles; food & beverage price growth slowed to +0.1% from +0.4% previously; excluding food & energy, the core CPI rose at a steady pace of 0.1%

$ US net long-term TIC flows accelerated to $68.6bn in September from $58.0bn in August amid the market turmoil and were the strongest since Nov’10; private foreign investors bought net $45.7bn in Treasury notes & bonds vs. $69.7bn in August, while “official” foreign investors ramped up purchases to $37.3bn after net sales of $8.7bn in August; however purchases have slowed sharply versus a year ago — in the 12 months through September, foreigners net purchases of US long-term securities were $472.0bn vs. $837.4bn in the 12 months through Sep’10

€ Eurozone CPI was confirmed at 3.0%YoY in October unchanged from September at the highest level since Oct’08; the core measure ex-energy, food, alcohol & tobacco held at 1.6%YoY, above the YTD average of 1.4%

£ The UK ILO unemployment rate rose to 8.3% in the 3 months through September from 8.1% in August; this marked a new cycle high and matched a level last seen 15 years ago in Jun’96; average earnings growth ex-bonuses was the weakest since Jul’10, at 1.7%YoY in the 3 months through September, down from 1.8%YoY in the 3m to August