French President Emmanuel Macron’s decision to call a snap election later this month has awakened investors to his nation’s chronic financial problems, raising alarms that a new free-spending French government will only make matters worse.
Markets were rattled by Macron’s election gamble, which followed an unexpectedly strong showing by the far-right National Rally in June 9 balloting for the European Parliament. The CAC 40 stock market in Paris sank 6 percent within days and French government bonds sold off, as investors fled to the relative safety of German alternatives.
With Macron’s centrist coalition losing public support, the extremes of the far left and far right are poised to shape whatever new government emerges from the parliamentary voting that begins June 30. Both the leftist New Popular Front and Marine Le Pen’s far-right National Rally support a long list of expensive government programs, despite a yawning budget deficit equal to 5.5 percent of output.
“The problem is there is no obvious path — given the prospective government’s plans — to lower this deficit. As long as we stayed in a crisis mode, it made sense to keep spending. But at some point, you have to stop,” said Davide Oneglia, director for European and global macro at TS Lombard in London.
GET CAUGHT UP
Stories to keep you informed
On Wednesday, the European Union’s executive arm chastised France and six other countries for incurring excessive budget deficits, in violation of the bloc’s fiscal rules. The statement begins a formal process that will force the spendthrift nations to negotiate a plan with Brussels to return to sound budgeting.
France’s plunge into political and financial uncertainty carries uncomfortable echoes of the European debt crisis that roiled the global economy from 2009 to 2012 and nearly drove debt-ridden countries such as Greece out of the euro zone.
Since the 2008 financial crisis, France has been able to borrow from investors at roughly the same interest rate as Germany, a country with a much lower debt and deficit burden. That now is changing.
“The market’s perception of risk in France has been re-priced because of the election. Whether that re-pricing has been adequate or not, I’m not sure,” said Neil Shearing, chief economist for Capital Economics in London. “There’s a risk of the financial situation deteriorating quite substantially from an already bad position. But I don’t think you end up with the wheels falling off.”
The French deficit — the E.U.’s second-largest behind only Italy — swelled after Macron spent heavily to ward off the pandemic and to protect voters from inflation, including by subsidizing energy prices.
France’s deficit — at 5.5. percent of output — is smaller than the United States’, which hit 6.2 percent in 2023, according to the Congressional Budget Office. But unlike the United States, France does not control its own currency and thus is more vulnerable to bond-market pressures.
Macron has promised to bring the deficit into compliance with the E.U.’s 3 percent annual target by 2027, when presidential elections are due.
But last month, Standard & Poor’s cut its rating of French government credit to AA- from AA, citing the likelihood that wider budget deficits would increase the public debt.
Some analysts worry that a new French government will further widen the budget deficit in defiance of Brussels, putting fresh strains on European politics and finances. Three polls released Thursday showed the National Rally earning the largest vote share, followed by the New Popular Front. Macron’s centrist group trailed in each of the surveys.
The National Rally, which roughly doubled the vote share of Macron’s party in the European elections, supports measures that would immediately add more than 12 billion euros to the 154 billion euro deficit, according to the Institut Montaigne, a nonprofit think tank in Paris. The rightists also back pension changes that would add more than 27 billion euros in costs by 2027.
In 2022, Le Pen ran for president on a platform that would have added 102 billion euros to the deficit, the institute said.
The New Popular Front, which includes France’s socialist and communist parties, vows to reverse Macron’s pension changes by lowering the retirement age to 60 from 64; link salaries to inflation; and, ramp up spending on public services.
On Friday, the left-wing coalition said it would raise taxes to offset a planned increase in public spending over time of 150 billion euros.
No one is sure how many of these campaign promises would survive the reality of governing. Some investors take solace in the example of Italian Prime Minister Giorgia Meloni. Though leading a far-right party with neo-fascist roots, Meloni since taking office in 2022 has moderated her rhetoric and policies.
“The only thing we know is that they have long lists of wishes that are very expensive,” Oneglia said.
French Finance Minister Bruno Le Maire has warned that France could suffer a “debt crisis” if the spending plans of either political extreme were enacted. The budget-busting programs would result in the country being placed under an austerity program supervised by the International Monetary Fund, he warned.
IMF officials already are raising concerns. The French government will need “substantial additional efforts” starting this year to strengthen its public finances, according to fund economists who visited Paris last month as part of a routine annual review.
The IMF team projects the budget deficit will decline only modestly to 4.5 percent of GDP in 2027, leaving it well above E.U. limits.
France has the world’s fourth-largest bond market, giving it a vital role in Europe’s fragmented financial landscape. French banks and businesses use government bonds as collateral in overnight “repo” or repurchase transactions, a key source of the routine short-term funding that supports daily commerce.
Since Macron gambled on snap elections, investors have demanded a higher return before buying French bonds. The yield or interest rate on France’s benchmark 10-year government security at the end of last year was around 2.4 percent. Now it hovers near 3.2 percent.
Though markets continue to function smoothly, trading is likely to remain volatile through the conclusion of the second round of parliamentary voting on July 7.
“It doesn’t mean France is the new Greece,” said Jacob Kirkegaard, an economist with the Peterson Institute for International Economics.
European Central Bank Chief Economist Philip Lane told Reuters last week there was no immediate need for central bank intervention, as market movements were not “disorderly.”
If a new government does upend markets by opening the spigot on spending, monetary authorities would probably be prepared to intervene.
The ECB is better prepared today to respond to a bond-market crisis than it was when Greece disclosed its hidden financial problems in 2010. Two years ago, the central bank approved a new mechanism that would allow it to purchase an unlimited amount of bonds from a government in distress.
Such purchases would be designed to prevent a speculative run that could drive up a government’s borrowing costs to punishing levels. To be eligible, a country is supposed to be in compliance with the E.U.’s fiscal rules. But in practice, the ECB has discretion about how to implement its own requirements.