Vasileios Gkionakis, Senior Economist & Strategist at Aviva Investors
This week, the French parliament voted down PM Michael Bernier’s proposed budget via a no confidence motion initiated by the far-right (RN) and leftwing (FI/NFP) parties. The proposed budget aimed at reducing France’s deficit from 6% of GDP closer to 5% over the next year or so. M Barnier is in the process of submitting his resignation as of the time of writing.
The turmoil has led to further widening of FR-GE 10Y spread, from 81bps (at the end of last week) to nearly 89bps, but it has stabilized since, closer to 77bps. More broadly and importantly, there is hardly any evidence that this could be turning into a systemic event: Italian, Greek and Spanish spreads have continued to tighten, illustrative of the idiosyncratic nature of French developments.
I will shy away from what politics exactly triggered the collapse and focus on what is coming next (incl. possible scenarios and market implications).
Without budget approval, the French constitution allows rolling over the 2024 budget, enabling tax collection and spending to maintain public services. This would mean modest fiscal consolidation and ongoing uncertainty. My view is that in such a scenario, the OAT-Bund spread would fluctuate between 80bps-100bps.
There is a path through which the proposed Barnier budget can be implemented but it would be by utilizing Article 16 of the French Constitution (Article 16 provides the President with “exceptional powers” at times of acute crisis). However, this is highly controversial and challenging: such a move would be politically damaging for President Macron at a times when his popularity is falling, and both left and far-right functions are gaining momentum. Note that such an act has never been used before.
A more plausible scenario would see President Macron appointing a new PM who then would proceed with more concessions to the far-right’s (quite comprehensive) demands so that Le Pen and her party would “allow” the budget’s approval. If so, my sense is that this would imply still a modest fiscal consolidation, though FR-GE spreads could consolidate at a lower range e.g. 60bps-80bps. Note that Marine Le Pen today said that the country can overcome the government collapse and agree on a budget soon as long as the next PM narrows the deficit more slowly.
But looking beyond the near term, general elections are almost certainly coming in early 2H 25 and opinion polls suggest that there will hardly be a resolution following the outcome. So political instability is likely to remain and keep French spreads wide; at the same time, to the extent that this remains an idiosyncratic issue I struggle to see any contagion to the rest of the region and broader markets.
There is, however, one scenario in which markets can become very unsettled: due to poor polling for his party, Macron may be tempted to appoint an RN government until the next elections take place in the hope that their inability to govern is exposed for everyone to see, reducing effectively their electoral power. This would be an extremely risky attempt because (1) RN would be fully aware of the President’s intensions and would very likely plan and accordingly implement prudently; and (2) Many unpredictable things can happen over a six month period that can shift political sentiment either way. If that came to pass, I would expect markets to become more unsettled, calling Macron’s gamble and potentially pricing in a higher probability of instability post the next elections.
Finally, I would like to end with two other important topics relating to Brussels and the ECB.
EU/EC response: France is currently under the Excessive Deficit Procedure (EDP) program which means that it should reduce it structural deficit by at least 0.5% of GDP during the first year (in the near term i.e. until 2027, interest payments can be excluded). This would be highly unlikely in the event of the 2024 budget rolling over (or an RN budget being adopted…). However, to the extent that there is even minimal progress, my understanding from various discussions is that there is no appetite for the EU to become vocal against France, especially now that it is preparing its response to potential Trump tariffs. Note however, that non-compliance would imply fines to the tune of 0.05% of GDP.
ECB response: on rates, unless there is emerging evidence of contagion, I doubt the ECB would be willing to cut interest rates beyond what it has in mind on the basis of inflation and growth projections. The Transmission Protection Instrument (TPI) is apparently gathering a lot of attention and many clients are asking whether it would be triggered: specifically for France, I highly doubt it (unless spreads explode to 150-200bps). The TPI is a mechanism to protect against yield deviations from economic fundamentals (so that monetary policy transmission is maintained); now consider that Greece and France are trading at the same level of spread, with France running a budget deficit of 6% and Greece below 1% – what would the basis be to trigger the TPI for France? Admittedly, the “requirements” for TPI implementation have been left very vague and these constitute only one input into the decision-making process of the Governing Council. Still, it seems unlikely that the ECB would decide to press ahead, especially because that would be seen as a green light to extreme political function to topple governments in the hope of being bailed out by the European Central Bank.
My bottom line is this: it is a very messy situation and unlikely to be resolved soon (and do not expect Macron to resign as incentives to do so are next to zero). French spreads will remain wide but unless extreme policies are implemented, they are unlikely to balloon sustainably above 100bps. In that scenario, the ECB does not respond, and the EU expresses concern but does not escalate. If spreads skyrocket and/or threaten with contagion then euro assets and EURUSD will come under pressure, and the ECB would likely be inclined to rethink its policy.
