By Yoruk Bahceli and Dhara Ranasinghe
(Reuters) – As far-right and left-wing parties gain momentum ahead of France’s surprise parliamentary elections, putting pressure on President Emmanuel Macron’s centrist government, investors are starting to consider the risk of a budget crisis at the heart of the eurozone.
Marine Le Pen’s far-right National Rally (RN) party is leading in opinion polls ahead of Macron’s June 30-July 7 vote, although it is unlikely to win an outright majority.
Although the RN has not yet announced a detailed programme, it has previously supported lowering the retirement age, tax cuts and boosting spending.
That has fueled concerns about fiscal sustainability in the eurozone’s second-largest economy, just weeks after France’s high budget deficit led to a credit downgrade.
A newly formed left-wing alliance, meanwhile, said on Friday it wanted to lower the retirement age and tie salaries to inflation, raising expectations for higher spending under a new government. An opinion poll on Wednesday showed left-wing parties in second place, behind the RN.
Investors’ reaction was blunt: The risk premium they demand to hold French government bonds versus the eurozone benchmark Germany rose to the highest level since 2017 on Friday, by almost 82 basis points, the biggest weekly increase since the eurozone debt crisis of 2011.
“Today the focus has shifted back to the possibility of some sort of near-term crisis,” said Gordon Shannon, portfolio manager at TwentyFour Asset Management.
“You’re assessing the risk of having an event similar to Britain’s mini-budget,” he said, referring to then-British Prime Minister Liz Truss’s mini-budget of unfunded tax cuts in 2022, which ravaged government bonds and forced the Bank of England to intervene to stabilize markets.
Finance Minister Bruno Le Maire, who is urging voters to back 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 sovereign debt against default rose on Friday to the highest level since May 2020, as banks took a hit from the spillover of rising borrowing costs.
Shares of the country’s three largest – BNP Paribas (OTC:), Credit Agricole (OTC:) and Societe Generale (OTC:) – are down between 12 and 16% this week, the highest level since the March banking crisis 2023. By Friday, they were all down at least 4%.
In a demonstration of how market turmoil is already hitting financing plans, a French state-backed agency has canceled a bond sale and France’s finance ministry plans to raise a smaller amount than normal at a bond auction next week.
Settlement in the eurozone?
Bond investors are often labeled vigilantes by analysts because they demand higher returns from governments they view as fiscally reckless.
“We have already had a stress test in Britain with the mini-budget, and last summer also in the US, when government bond yields rose sharply after the announcement of government bond redemptions,” said Guillermo Felices, global investment strategist at PGIM Fixed Income .
“We have not yet had this in the eurozone.”
The Institut Montaigne think tank has looked at the RN’s program for the 2022 parliamentary elections and said it would cost more than 100 billion euros – suggesting a 3.5 percentage point increase in France’s budget deficit – if it is fully implemented implemented. That’s much higher than the Truss tax cut estimates.
RN President Jordan Bardella said Friday that the party would describe its platform in the coming days and how it would be financed. So far, it has been unclear where it stands on fiscal responsibility, beyond blaming the outgoing government for squeezing public finances.
“In an extreme case, the risks could include a Liz-Truss-style blowout of interest rate spreads,” Holger Schmieding, chief economist at private bank Berenberg, said earlier this week.
Britain’s 10-year yield rose by more than 100 bps in less than a week during the budget crisis, while France’s yield rose just 6 bps this week.
There were some early signs that concerns about France could spread across the eurozone.
Italy’s closely watched risk premium over Germany rose 159 basis points on Friday to the highest level since February.
Italy recorded the highest budget deficit ratio in the European Union last year, at 7.4% of output. The country, together with France, is expected to face an excessive deficit procedure by the European Union, which will require the country to reduce its structural deficit.
The euro hit a 1.5-month low against the dollar on Friday and euro zone bank stocks have fallen almost 10% this week.
The bloc’s financial architecture is seen as much stronger than the debt crisis of a decade ago, with the European Central Bank repeatedly showing it will step in with new tools to stabilize markets in times of crisis.
However, Patrick Saner, head of macro strategy at Swiss Re (OTC:), noted that the ECB’s backstop to buy government bonds when justified requires compliance with EU fiscal rules to qualify.
“That may raise some doubts around the ECB’s support,” he said.
Others said it remained to be seen how a potential government in France, which included the RN, would act in office. Italy’s debt performed better last year, thanks to help from far-right Prime Minister Giorgia Meloni to moderate her tone in office.
Iain Stealey, global chief investment officer for fixed income at JPMorgan Asset Management, said the RN’s spending plans would be curbed by the EU’s deficit rules.
“The market will also play a key role in containing the National Rally, with the party likely to adopt a more cautious fiscal stance ahead of the 2027 presidential election,” he added.
