Standard & Poor's was poised to downgrade the credit ratings of several euro zone countries on Friday, including France and Austria but not Germany or the Netherlands, rattling markets in the first blow of the new year for the troubled single currency.
In another potential setback, talks on a debt swap by private creditors seen as key to averting a Greek default that would rock Europe and the world economy broke up without agreement in Athens, although officials said more talks are likely next week.
Four euro zone government sources said S&P would cut a number of the currency bloc's sovereigns, making an announcement after New York markets close at 4 p.m. EDT (9 p.m. British time).
A euro zone official said France and Austria would lose their top-notch triple-A ratings, and Slovakia would also be affected. The Financial Times reported that France and Austria would each drop one notch to AA+.
There was no official comment in Paris but Reuters reporters saw Finance Minister Francois Baroin arrive at President Nicolas Sarkozy's office in the late afternoon.
Government spokeswoman Valerie Pecresse told BFM television: France today is a safe investment. It can repay its debt and the news concerning our deficit is better than expected.
The euro fell by more than a cent to $1.2650 on the news. European stocks, which had been up on the day, turned negative. Safe-haven German 10-year bond futures rose to a new record high while the risk premium investors charge on French, Spanish and Belgian debt widened in reaction.
Greek negotiators who have repeatedly voiced confidence in a deal in which banks and insurers would accept voluntary losses of 50 percent of the face value of their bond holdings said they were now less hopeful, warning of catastrophic consequences for Greece and Europe if they failed.
Without a deal, a second Greek bailout package could fall apart, leaving Athens facing default in March when it must meet massive bond repayments.
Yesterday we were cautious and confident. Today we are less optimistic, a source close to the Greek task force in charge of the negotiations said.
The Institute for International Finance, negotiating on behalf of creditor banks, said in a statement: Under the circumstances, discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach.
The double blow of the S&P news and the stalling of the Greek debt talks came after a brighter start to the year with Spain and Italy beginning their marathon debt rollover at lower borrowing costs this week.
The European Central Bank's move last month to flood banks with cheap three-year liquidity helped ease a worsening credit crunch and provided funds which governments hope some will use to buy sovereign bonds.
RESCUE FUND WEAKENED
S&P declined comment on reports of an imminent downgrade, which several sources said would not affect the triple-A ratings of Germany or the Netherlands. There was no word of a threat to the euro zone's other AAA states, Finland and Luxembourg.
France and Austria were both seen as being at greater risk because of their banks' exposure to the debt of peripheral euro zone countries and Hungary respectively, and the weakening economic outlook for Europe.
S&P warned on December 5 that it was reviewing the ratings of 15 of the 17 euro zone members, including Germany and France, the region's two biggest economies, for a possible mass downgrade due to rising systemic stresses in the currency area.
The agency said it would issue a decision within three months, but as soon as possible after a December 9 summit at which euro zone countries agreed to negotiate a fiscal pact with tougher enforcement of budget discipline.
A cut in France's rating would be a serious setback for the centre-right Sarkozy's chances of re-election in May and could weaken the euro zone's rescue fund, reducing its ability to help countries in difficulty.
France is the second largest guarantor of the European Financial Stability Facility, which currently has a AAA rating. Preserving that status would require members to increase their guarantees, which could prove politically unpopular.
After vowing to do everything to preserve Paris' top-notch standing, Sarkozy appeared to prepare voters last month for the likely loss of the prized status before the election.
It would be one more difficulty, but not insurmountable, he said in an interview with Le Monde.
France has the highest debt-to-gross-domestic-product ratio of the euro zone's AAA-rated countries, and the government has refused to take further savings measures before the election, insisting it can meet its fiscal targets.
It was not clear how far a downgrade would increase France's borrowing costs, since markets have already anticipated the prospect by raising the French risk premium over German Bunds.
One notch is priced in but not more. The Franco-German spread can widen. It is about 130 basis points for the 10-year bond. The maximum level reached was 180 to 190 basis points and it can go back to this level, said Alessandro Giansanti, senior rates strategist at ING in Amsterdam.
(Additional reporting by Annika Breidthardt in Berlin and Reuters euro zone bureaux; Writing by Paul Taylor, editing by Mike Peacock)