A potential downgrade of all euro zone countries by Standard & Poor's could raise the cost of borrowing for the region's bailout fund, but would otherwise not make a big difference to the fund's operations, euro zone officials say.

Standard & Poor's is due to decide whether to downgrade euro zone countries in the coming days, following an EU agreement last week to forge tougher fiscal rules.

A broad rating cut for 15 of the euro zone's 17 countries, if it happens, would mean the bailout fund, the European Financial Stability Facility (EFSF), which relies on guarantees from euro zone countries, would itself lose its triple-A credit rating.

If there is an across-the-board downgrade of all euro zone countries, the whole yield structure in the euro zone would probably move together. The spread of the EFSF over Germany would probably remain the same, one euro zone official said.

Thanks to guarantees from euro zone countries, six of which still have a triple-A rating, the EFSF can borrow up to 440 billion euros on the market cheaply and re-lend the money to sovereigns cut off from market financing.

As EFSF costs are paid by euro zone countries who would otherwise have to borrow by paying double-digit yields, a relatively small rise in the cost of EFSF loans would not be a huge blow to countries under an EU/IMF bailout programme.

The financing conditions of programme countries would remain extremely favourable compared to their own condition on the market, a second euro zone official said.

Officials also noted that when Standard & Poor's cut the triple-A rating of the United States in August, investors, instead of selling U.S. debt, actually bought U.S. treasuries because they were a safe-haven asset.

Double-A is the new triple-A, said one European banker, shrugging off the implications of any downgrade.

As German bonds are considered a European safe-haven asset, a downgrade of Germany might not have a dramatic impact on its bond prices either, officials said.

This could also help the EFSF.

Borrowing costs may go up, but if for example Germany's borrowing costs do not go up after the downgrade, why should those of the EFSF? a third euro zone official said.

The EFSF sold a 10-year bond on November 7 with a yield of 3.59 percent. On that day, the benchmark 10-year German bond yield was at 1.79 percent on the market.

By comparison Portugal, which gets funding from the EFSF, would have to pay more than 13 percent to borrow money for 10 years, and Greece an astronomical 33 percent.

POTENTIAL FRENCH DOWNGRADE

However, an S&P downgrade of only one major EFSF guarantor, for example France, could substantially reduce the fund's lending capacity, especially if the aim was to retain the facility's triple-A rating.

If France were to be downgraded, the EFSF would lose 20 percent of its firepower in the first-round effect, a fourth euro zone official said.

This is because the guarantees extended by the remaining triple-A countries would be able to cover a smaller amount of triple-A debt issuance by the EFSF.

The fourth official said there were no plans to let the EFSF lose its triple-A rating in order to preserve its firepower in case of such a selective downgrade, but the official added: Opinions tend to evolve with facts.

Jean-Michel Six, S&P's chief economist, said on Monday that last week's EU agreement on a fiscal compact involving more fiscal discipline for euro zone countries was a significant step forward, but not enough.

There is probably yet another shock required before everybody in the euro zone reads from the same page, for instance a major German bank experiencing some real difficulties on the markets, which is a genuine possibility in the near term, Six told a conference in Tel Aviv.

Then there would be a recognition that everybody is indeed on the same boat and that even German institutions can be affected by this contagion. I'm afraid this may still be required, Six said.

While markets appear to have already partially priced in the threat of a downgrade for the whole of the euro zone, yields are likely to rise even further if it happens, economists say.

We are in a very fragile situation and a further blow to sentiment, which an across-the-board adjustment by S&P would be, would have a detrimental effect on markets, said Mark Wall, chief euro area economist at Deutsche Bank.

Market reaction to such a downgrade would depend to a large extent on how S&P justified its decision.

If it is political dysfunction and disunity within the euro zone it could give investors more reasons to be concerned about the structure and sustainability of the EFSF, Wall said.

It could have a disproportionately big effect compared to the downgrade, he said, adding that when S&P put the euro zone on negative watch it was partly on account of insufficient euro zone integration and partly because of concern about the ECB's willingness to play a compensatory role.

While the EU summit may have helped ease concerns about fiscal integration, the ECB's reluctance to step in as a lender of last restort has remained as strong as ever.

(Editing by Susan Fenton)