After downgrades, all eyes on ECB

The evidence is growing that eurozone governments will take the downgrade of their bailout fund, the European Financial Stability Facility, on the chin, rather than putting in more of their own resources to restore its AAA rating.

In theory, as Klaus Regling, boss of the EFSF, has said, the EFSF will still have the 150bn euros needed for the second bailout of Greece and to help strengthen the eurozone's banks.

But it may become more expensive for the EFSF to raise money.

Also most analysts fear the downgrade has put paid to hopes and ambitions for the size of bailout resources to be significantly boosted - which is widely believed to be necessary, if investors are to be reassured that there won't be devastating contagion from Greece's woes to Portugal, Ireland, Italy and Spain, or tumbling default dominoes.

In theory, I suppose, France and Germany could stop worrying about maintaining the EFSF's rating at a superior level, or a level at least equivalent to that of France. But if they were to do that, then the EFSF might find it hard to raise any money at all.

Unstable stability mechanism

So, as I said yesterday, the eurozone's leaders have an uncomfortable choice between maintaining the EFSF's current resources - deemed as meagre by many - at the new lower AA plus rating, and finally giving up on the idea of leveraging or boosting the fund (because that kind of financial engineering is harder in the absence of an AAA).

Or they could stretch their own balance sheets more to strengthen the EFSF. But Germany has indicated that's highly unlikely - and as the fund's biggest guarantor, Germany calls the shots.

Whichever route they take, there is one unavoidable conclusion. The EFSF will be seen by investors as being even less equipped than it was to do everything it may be called upon to do.

However in theory there will be another 500bn euros available for rescues, if eurozone leaders succeed in creating the successor to the EFSF, the European Stability Mechanism, in July. That said, the downgrades of France and Austria have created technical problems for the ESM's construction.

All of which means that for the foreseeable future there will be even more pressure on a reluctant European Central Bank to intervene in government bond markets to keep implicit borrowing costs for Spain and Italy below penal levels.

UPDATE 9:21 GMT

The eurozone's banks plainly don't believe the acuteness of the financial crisis has diminished. They are hoarding cash to an unprecedented extent - having placed a record 502bn euros on overnight deposit at the European Central Bank.

It is not healthy for the eurozone economy that European banks would rather place their money at a loss with the ECB, where they perceive it to be safe, rather than lend it to each other or to businesses and households.