France is grappling with a severe economic and political crisis, which came to light after Moody’s downgraded the country’s credit rating from Aa2 to Aa3. The decision was justified by concerns over France’s high borrowing needs and the poor state of public finances. Although the market reaction was limited, pressure on French bonds increased, with yields on 10-year bonds rising to 3.07%. The spread between French and German bonds is currently 81 basis points, with projections indicating further increases, highlighting the growing investment risk.
The economic situation is exacerbated by political instability. Following a vote of no confidence, former Prime Minister Michel Barnier was dismissed and replaced by François Bayrou. This vote was made possible by a surprising alliance between the right-wing Marine Le Pen and leftist parties, who jointly opposed strict budget-cutting plans. The new prime minister assumed office under challenging circumstances — the parliament is deeply divided, and none of the three major political blocs (the left-wing New Popular Front, President Macron’s centrist supporters, and Le Pen’s right-wing group) hold a sufficient majority.
Bayrou faces several key tasks, the most urgent of which is passing an interim budget for 2025 to avoid a financial paralysis of the state. The next step will be developing a plan to reduce the deficit from the current 6.1% to 5% of GDP. This will require a combination of public spending cuts and tax increases totaling €60 billion. However, achieving consensus in such a polarized parliament will be extremely difficult.
The opposition has made their conditions clear: rejecting the continuation of President Macron’s policies and avoiding the use of a constitutional article that allows passing laws without a vote. Bayrou will have to negotiate with both the left and the far right, while avoiding becoming overly reliant on Le Pen’s party.
Despite the tense political situation, some investors, including hedge funds, still show limited confidence in French bonds. However, experts such as Societe Generale warn of a “slow rise” in spreads, pointing to the government’s weakness and the lack of clear prospects for fiscal consolidation. If France does not take effective action, rising debt servicing costs could significantly hinder long-term public finance stabilization.
France stands on the brink of a political-economic crisis, and stabilization requires swift action and compromise. The success of Bayrou’s government depends on his ability to overcome parliamentary divisions and pass a balanced budget. Without this, the country risks further increases in financing costs and deepening economic problems, which could permanently undermine investor confidence.
Author: Krzysztof Kamiński, OANDA TMS Brokers
