Investors are concerned that France might face a financial crisis if the upcoming parliamentary elections result in the collapse of the political center, potentially placing far-right populists at the helm of the EU’s second-largest economy.
After his party’s defeat to the far right in a recent EU parliament vote, President Emmanuel Macron called for snap elections, a decision that unsettled the markets affecting French stocks and government bonds significantly.
Since then, there’s been ongoing speculation that the National Rally, led by Marine Le Pen, could become the most dominant party in parliament, potentially displacing Macron’s centrist alliance. This shift could complicate efforts to reduce France’s substantial government debt, which was 110.6% of GDP at the end of the previous year, and might even increase it. A highly divided parliament could also face challenges in reducing the budget deficit, which was 5.5% of GDP last year.
Economists from Berenberg have suggested that if Le Pen dominates parliament and implements significant portions of her costly fiscal and protectionist ‘France first’ agenda, it could lead to a financial crisis similar to that experienced under Liz Truss in the UK. Truss’s tenure saw a sharp sell-off in the British pound and government bonds after she proposed borrowing increases to fund tax cuts, which led to her quick resignation as she became the shortest-serving prime minister in UK history.
France’s Finance Minister, Bruno Le Maire, acknowledged the real risk of a financial crisis due to the political unrest caused by the snap elections. He remarked on franceinfo, a French radio station, that France’s borrowing costs have now surpassed those of Portugal, which had been bailed out during the past European debt crisis.
Credit rating agencies are closely monitoring France, one of the EU’s most indebted nations. In May, S&P downgraded France’s long-term credit rating to AA-, pointing to a worsening budgetary situation, though it still sees France as capable of repaying its debts. They predict the budget deficit might decrease to 3.5% of GDP by 2027, still above the government’s target of 2.9%.
The uncertainty surrounding the political situation has already impacted the markets. Yields on France’s 10-year government bonds have risen, and the premium demanded by traders to hold French over German bonds reached a peak not seen since 2017. French stock markets and the euro have also been affected negatively this week.
An opinion poll conducted by Elabe for CNN affiliate BFMTV and La Tribune Dimanche indicated that Macron’s centrist group might only place third in the initial round of the elections on June 30, trailing behind the National Rally and a left-wing alliance.
The National Rally’s promises to increase public spending and cut VAT on electricity and fuel could further strain public finances, according to market analysts. Frank Gill from S&P Global Ratings highlighted that such policies could negatively impact the sovereign rating. Similarly, Moody’s noted that the snap elections pose increased risks to France’s fiscal consolidation, marking it as a credit negative.
The European Central Bank has the capacity to prevent a severe crisis in the French bond market, as per a Berenberg note. However, the ECB’s intervention might only occur if the country returns to more prudent fiscal policies, reflecting a similar stance during the previous euro crisis.
