France said on Tuesday it would respond to a Moody's credit downgrade by pushing on with reforms, complaining that the ratings agency had overlooked steps already taken to revamp the euro zone's second-largest economy.
France lost its prized triple-A badge from the Standard & Poor's agency in January, so Monday's move by Moody's was not surprising. But it underlined doubts about Socialist President Francois Hollande's ability to fix France's public finances.
The downgrade also highlighted the divergence with the top-rated regional powerhouse Germany whose finance minister called it a "small warning" to its most important euro zone partner.
Hollande said after the cut: "We must take note, stick to our economic policies, keep on track and understand that we have every interest in improving public finances."
Moody's said it would assess the triple-A ratings of the euro zone's EFSF and ESM bailout funds in light of its one-notch cut of France to Aa1 with a negative outlook.
However, its France downgrade did not appear to affect the perceived status of French bonds which, along with German debt, are seen as a safe haven from the crisis in southern Europe.
The benchmark French 10-year government bond yield - which has been trading at historic lows and offering Hollande crucial access to cheap borrowing - was little changed at 2.15 percent versus 2.08 percent before the downgrade.
"Moody's raised concerns about France's capacity to reform and so it is up to us to show that this time we are going to carry out reforms," Finance Minister Pierre Moscovici, leading a government offensive to play down the move, told journalists.
"The rating change does not call into question either the economic fundamentals of our country, the efforts undertaken by the government or our creditworthiness."
The government is planning the toughest belt-tightening effort in 30 years in 2013 but must also try and halt a growth slow-down that has seen unemployment surge to 13-year highs.
Moody's said it kept a negative outlook on France due to structural challenges and a "sustained loss of competitiveness" in the country, where business leaders blame high labor charges for dragging down exports. It also cited "sizable exposures" of its banks to weak, southern euro zone countries.
"The first driver ... is the risk to economic growth, and therefore to the government's finances, posed by the country's persistent structural economic challenges," Moody's said.
The downgrade initially nudged the euro 0.30 percent lower to 1.2770 against the dollar late on Monday but the currency recovered some ground to trade at 1.2805 at 1730 GMT on Tuesday.
Deutsche Bank economist Gilles Moec said the fact the downgrade was largely priced in did not take the pressure off Hollande to show he will pursue more reforms, with an overhaul of rigid hiring and firing rules seen as the most pressing.
"Public opinion in France - as well as the market ultimately - will expect a reaction from the executive," Moec said. "The market ... is giving France the benefit of the doubt, but a further clarification of the policy stance is becoming urgent."
Moody's said it could cut France again if efforts to free up the rigid labor market and overhaul an economy where public spending accounts for 57 percent of output ran into trouble.
"We would downgrade the rating further in the event of an additional material deterioration in France's economic prospects or in a scenario in which there were difficulties in implementing the announced reforms," Moody's lead France analyst Dietmar Hornung told Reuters.
He said more big shocks from the euro zone debt crisis would also exert downward pressure on the rating.
The downgrade follows concerns raised by the IMF that France could be left behind as Italy and Spain reform at a faster pace.
"The government has sent positive signals on public finance commitments and competitiveness. However, more is required," said Societe Generale's Michel Martinez, who like many analysts sees French growth falling short of 2013 budget estimates.
But analysts see French bonds remaining resilient for now.
"The French debt market is highly liquid and remains a favored venue for international investors, particularly in a world where 'double-A' is becoming the norm among Western states," Barclays France director Franklin Pichard said.
Yet with Germany one of the few major economies to retain a triple-A rating, the move is likely to reinforce Berlin's role as the capital calling the shots in the 17-country euro zone.
Michael Grosse-Broemer, parliamentary whip of German Chancellor Angela Merkel's ruling CDU party, told Reuters the downgrade gave fresh impulse to France to fulfill its reforms.
Finance Minister Wolfgang Schaeuble said the move was a warning for everyone in Europe to meet their responsibilities.
With France's 2-trillion-euro economy teetering on the brink of recession, Hollande surprised many this month by granting 20 billion euros in annual tax relief to companies, equivalent to a 6 percent cut in labor costs, to spur competitiveness.
The government also plans 30 billion euros in budget savings next year to trim its deficit and has promised reforms next year to add flexibility to rigid labor laws.
"Certain criticisms are too strong or are too late. I would have preferred that the bold and unprecedented decisions on the crisis were better received," Moscovici said of Moody's.
He said it was unfair to flag concerns over French banks as they have cut exposure to troubled euro states such as Greece.
"I don't expect (the downgrade) to have an immediate knock-on impact today on access to and cost of funding," said Espirito Santo analyst Andrew Lim of any impact on the banking sector.
But he said France's exposure to Spain, Italy and peripheral Europe should be kept in mind.
As far as government borrowing goes, France has completed its issuance for 2012. Demand is strong from foreign buyers, who hold 55 percent of its long-term bonds, but the downgrade could be a trigger to bet on yields rising next year.
"Our view is the market is teeing itself up to short France in 2013. It's the trade everyone wants to get into," said Lyn Graham-Taylor at Rabobank in London.
(Additional reporting by Blaise Robinson, Alexandre Boksenbaum-Granier and Andreas Rinke; Writing by Mark John; Editing by Peter Graff)