Talks to stave off US fallout

EUROPE'S central bank governors were due to hold emergency talks overnight intended to stop Spain and Italy from becoming the next victims of the sovereign-debt crisis and limit fallout from the first US credit-rating cut in history.

Local traders - still reeling from Friday's $55 billion rout - fear a negative reaction to Standard & Poor's decision to downgrade US sovereign debt to AA could drive share prices lower.

Last night, futures markets were still assessing the impact, pointing to a slight fall in the Australian sharemarket when it opens this morning.

"The downgrade adds to global uncertainties, underlines once again the decline, fragilities and weaknesses of the world's largest economy and is a stunning indictment of the shortcomings of policymaking in Washington over an extended period - the US should, in short, not be in this position," Westpac's head of interest rates strategy, Russell Jones, said.

Former treasurer Peter Costello, who helped steer Australia back to a AAA rating, said it was tougher for a country to recover following a downgrade.

In 1986, Moody's and Standard & Poor's cut Australia's AAA rating to AA-level, largely on concerns about spiralling government debt.

''The AAA credit rating is very hard to recover once it has been lost. Once it is lost debt servicing costs rise and make it much more difficult to balance a budget, let alone repay debt. The message is to never lose the status in the first place,'' Mr Costello told BusinessDay.

''Australia was shocked to be downgraded from a AAA rating in the late 1980s. It took us outside the group of those countries considered first class in economic management and financial strength.''

Meanwhile, US billionaire Warren Buffett argued Standard & Poor's erred when it lowered the US credit rating and reiterated his view that the US economy will avoid its second recession in three years.

''Financial markets create their own dynamics, but I don't think we're facing a double-dip recession,'' Mr Buffett, chairman and chief executive of Berkshire Hathaway, told Bloomberg. ''Clearly, what stockmarkets do have is an effect on confidence and this sell-off can create a lack of confidence.''

Many superannuation funds are obliged to have their money in AAA-rated bonds, while other investors will stand back, wary of the volatility in equity markets that is expected to follow.

Analysts also predict a rush on safe-haven currencies such as the Swiss franc and the yen, but were divided over the immediate effect on the Australian dollar. ''Since the Australian dollar often acts as a barometer of global financial market sentiment'', downward pressure on the dollar might well be the initial outcome, Commonwealth Bank chief economist Michael Blythe said.

Global investors are expected to flock to Australian bonds, pushing down borrowing costs for Canberra and some state governments.

Australia is now part of a small handful of countries with a AAA rating. With public debt of 26 per cent of GDP - compared with the OECD average of 100 per cent - it is not in danger of losing that status.

Investment bank RBS said the downgrade was likely to reinforce the continuing buying of Australian debt by overseas investors moving away from US government debt and push Australia's dollar up, as bonds dominated local capital flows.

''Australia seems in very little danger of seeing its rating change,'' the company said.

It said last week's market volatility has effectively sidelined the Reserve Bank when it comes to setting interest rates.

''The RBA came close to hiking last week as it now forecasts above inflation for the next three years, but extreme global uncertainty will stay its hand until it becomes clear whether there will be a significant affect on Australia.''

After Thursday's savage rout, the US market swung more than 400 points on Friday as investors were buffeted by news about the weak US economy and Europe's debt problems.

At the close of trading on Friday, which came before the downgrade, the broader market as measured by the S&P 500 Stock Index ended down 0.69 points at 1199.38, for a drop of 7.1 per cent over the week. Australia's benchmark S&P/ASX 200 Index lost 7.2 per cent over the past week. That followed Friday's 171.1-point loss to close at 4105.4 points.

The US downgrade is also expected to push the price of gold higher, despite a slip from its record of $US1684.90 to $US1651.80 an ounce in New York on Friday.