Yoruk Bahceli and Dhara Ranasinghe
(Reuters) – As far-right and left-wing parties gain momentum ahead of a surprise parliamentary election in France, putting pressure on President Emmanuel Macron’s centrist administration, investors are beginning to speculate about the risk of a budget crisis in the euro zone’s heartland.
Marine Le Pen’s far-right National Rally (RN) party is leading in opinion polls ahead of elections scheduled by Macron for June 30 and July 7, although it is unlikely to win an absolute majority.
While the government has yet to announce its detailed program, it has previously advocated lowering the retirement age, cutting taxes and increasing spending.
It raised concerns about the financial strength of the euro zone’s second-largest economy just weeks after France’s high deficit led to a credit rating downgrade.
Meanwhile, a newly formed left-wing alliance said on Friday it wants to lower the retirement age and link wages to inflation, raising expectations of higher spending under the new government. An opinion poll on Wednesday showed left-wing parties in second place behind PH.
The reaction from investors was sharp: the risk premium they demand to hold French government bonds over Germany’s eurozone benchmark rose on Friday to its highest level since 2017, up nearly 82 basis points, the biggest weekly jump since the debt crisis eurozone in 2011.
“Today the focus has shifted again to the possibility of some kind of short-term crisis,” said Gordon Shannon, portfolio manager at TwentyFour Asset Management.
“You’re assessing the risk that you’ll have an event like a UK mini-budget,” he said, referring to then-UK Prime Minister Liz Truss’ mini-budget of unfunded tax cuts in 2022 that dealt a blow to bonds and forced the Bank of England to intervene to stabilize markets.
Finance Minister Bruno Le Maire, urging voters to support Macron’s centrist candidates, warned on Friday of the risk of a financial crisis if the far right or left win the election.
The cost of insuring France’s debt against default jumped on Friday to its highest level since May 2020, while the fallout from rising borrowing costs hit banks.
Shares of the country’s three largest companies – BNP Paribas (OTC:), Credit Agricole (OTC:) and Societe Generale (OTC:) – have lost 12-16% this week, the most since the banking crisis in March 2023. All stocks fell at least 4% on Friday.
Showing how market turmoil is already affecting funding plans, a French government agency has canceled a bond sale and the French Treasury plans to raise a smaller amount than usual at a bond auction next week.
EUROZONE CALCULATION?
Bond investors are often called vigilantes by analysts for demanding higher returns from governments they view as fiscally reckless.
“We already had a stress test in the UK with the mini-budget, and we did one in the US last summer when Treasury yields rose sharply after the Treasury bailout was announced,” said Guillermo Felices, global investment strategist at PGIM fixed income .
“This has never happened in the eurozone before.”
The think tank Institut Montaigne examined the RN program for the 2022 parliamentary elections and said that if fully adopted, it would cost more than 100 billion euros, implying a 3.5 percentage point increase in France’s budget deficit. This is much higher than Truss’s tax cut estimates.
RN President Jordan Bardella said on Friday the party would detail its platform and how it would be financed in the coming days. It has so far been unclear about its position on fiscal responsibility, other than blaming the outgoing government for overstretching public finances.
“At the extreme, risks could include a Lees-Truss-style spike in yield spreads,” Holger Schmieding, chief economist at private bank Berenberg, said earlier this week.
UK 10-year yields jumped more than 100 bps. in less than a week during the budget crisis, and French bond yields rose just 6 bps this week.
There were some early signs that worries about France could spread to the eurozone.
Italy’s risk premium over Germany rose to its highest level since February at 159 bps. on Friday.
Italy last year had the highest budget deficit-to-GDP ratio in the European Union, at 7.4% of GDP. Along with France, it is expected to face the EU’s excessive deficit procedure, which requires it to reduce its structural deficit.
The euro hit a month-and-a-half low against the dollar on Friday, and eurozone bank shares have fallen nearly 10% this week.
The bloc’s financial architecture is seen as much stronger than its debt crisis more than a decade ago, with the European Central Bank repeatedly showing it would use new tools to stabilize markets during the crisis.
However, Swiss Re (OTC:) head of macro strategy Patrick Saner noted that the ECB’s instrument for buying government bonds, if warranted, requires compliance with EU fiscal rules to qualify.
“This may raise some doubts about the ECB’s support,” he said.
Others said it remains to be seen how a potential government in France that includes the RN would act in office. Italy’s debt has exceeded last year’s figure, helped by far-right Prime Minister Giorgia Meloni softening her tone in office.
Ian Steely, global director of fixed income investments at JPMorgan Asset Management, said RN’s spending plans would be constrained by EU deficit rules.
“The market will also be a key force controlling the National Rally, and the party is likely to take a more prudent financial position ahead of the 2027 presidential elections,” he added.