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French borrowing costs rose to their highest since March and stocks sold off for a second day on Tuesday, as investors reacted to the prospect of a government collapse as soon as next month.
Prime Minister François Bayrou on Monday called a confidence vote for September 8 over his deficit-cutting budget proposals.
Lawmakers have two weeks to “say whether they are on the side of chaos or on the side of responsibility”, Bayrou said as he addressed union members on Tuesday. “The first risk, the one from which we would not recover, is denial.”
Finance minister Éric Lombard said on Tuesday that the government “certainly was not resigned” to losing the confidence vote. But he warned that there was a risk the IMF could step in if the government were to fall next month and subsequent administrations fail to tackle the country’s finances.
“This is the risk that is in front of us . . . [that] the financial situation deteriorates, which we would like to [and] should avoid. But I can’t tell you that this risk doesn’t exist,” he told France Inter radio.
France’s 10-year borrowing costs climbed as high as 3.53 per cent, approaching the post-Eurozone crisis high set in March. They later came back a little to 3.5 per cent. The additional interest rate over Germany’s benchmark Bunds reached almost 0.8 percentage points, close to its peaks during the past year’s political crisis.
The country’s blue-chip stock index, the Cac 40, fell 1.7 per cent, adding to a 1.6 per cent decline on Monday.
“The risk the market sees is that if the government falls again, it’s complete stalemate and there’s no chance of tackling the deficit,” said Peter Schaffrik, chief European macro strategist at RBC Capital Markets.
Opposition parties in parliament, including crucial swing blocs such as the Socialists and the far-right Rassemblement National, have said they will not support the government, making it all but inevitable that Bayou’s administration will fall.
Bayrou’s proposed package of €44bn in tax rises and spending cuts for 2026, including a one-year freeze on state spending and cutting two days of national holiday, has been rejected by opposition lawmakers. Lombard said that while there was room to negotiate on some measures in the plan, the government would not compromise on its €44bn target.
No party has held a clear majority in France’s fragile parliament since President Emmanuel Macron called and lost snap elections a year ago. The government of Bayrou’s predecessor collapsed in December after a few months in power.
Emmanuel Cau, head of European equity strategy at Barclays, said the falling market was pricing in two risks on Tuesday morning: “political instability and more fiscal indiscipline”.
“The equity market was complacent,” Cau said, noting that the stock market had been rising in recent months despite signs of stress in the bond market. “A lot of this was about investors buying the European revival story,” he said.
However, “there is a limit to how much bond market stress [equities] can ignore”, Cau said. “Now we are seeing a bit of convergence between stocks and bonds.”
Domestic-facing stocks were hit particularly hard. Shares in the country’s biggest banks, seen as proxies for the wider economy, were the most affected. BNP Paribas, Société Générale and Crédit Agricole were all down 4 per cent or more.
France’s slow-rolling political crisis has seen its borrowing costs converge with Italy’s in recent months, for the first time since the global financial crisis. Lombard said France’s borrowing costs would exceed Italy’s “within 15 days” if the government lost the vote.
On Tuesday, the gap closed further, with the yield on 10-year French government bonds less than 0.1 percentage point below Italy’s.
Nicolas Trindade, a senior portfolio manager at Axa Investment Managers, said he expected French government bonds to underperform because the “likelihood of a government collapse has sharply risen, since main opposition parties have signalled they’ll vote against the Bayrou government”.
He said installing a new prime minister “would not change parliamentary arithmetics”, so any meaningful fiscal consolidation “would still be very difficult to implement”. He said a snap election “would run the risk of the far right getting an outright majority this time around”.
Mujtaba Rahman, managing director for Europe at Eurasia Group, said the firm’s base case was that the prime minister would be unseated on September 8.
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The euro rallied slightly against the dollar on Tuesday, paring losses from Monday when the currency fell 0.8 per cent.
“The broader question for the euro is whether recent French news destabilises appetite for the euro more broadly, or whether this is an isolated French issue,” said Chris Turner, global head of markets research at ING.
Analysts at Barclays forecast a “virtually unchanged” French deficit over the next two years, equal to 5.6 per cent of GDP in 2025 and 5.4 per cent in 2026, after 5.8 per cent last year. The government is targeting 5.4 per cent this year and 4.6 per cent in 2026, in a four-year plan announced last month aimed at bringing France’s deficit in line with the EU’s 3 per cent limit.
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