By Yoruk Bahçeli and Dara Ranasinghe
(Reuters) – As far-right and left-wing parties gain momentum ahead of snap parliamentary elections in France, putting pressure on President Emmanuel Macron's centrist administration, investors are beginning to consider the risk of a budget crisis at the heart of the euro zone.
The far-right National Rally party, led by Marine Le Pen, is leading in opinion polls ahead of the elections called by Macron on June 30 and July 7, although it is unlikely to win an absolute majority.
Although it has not yet announced its detailed program, the National Front party had previously favored lowering the retirement age, lowering taxes, and increasing spending.
This has exacerbated concerns about fiscal sustainability in the euro zone's second-largest economy just weeks after a rise in France's deficit led to a credit rating downgrade.
Meanwhile, a newly formed left-wing coalition said on Friday that it wants to lower the retirement age and link salaries to inflation, raising expectations of increased spending under the new government. An opinion poll conducted on Wednesday showed that leftist parties came in second place behind the National Rally Party.
Investors reacted bluntly: The risk premium they require for holding French government bonds above the German euro zone index rose to its highest level since 2017 on Friday at nearly 82 basis points, its biggest weekly jump since the 2011 euro zone debt crisis.
“Today the focus has shifted back to the scope of some type of near-term crisis,” said Gordon Shannon, portfolio manager at TwentyFour Asset Management.
“You're pricing in the risk of having an event similar to the UK mini-budget,” he said, referring to then-UK Prime Minister Liz Truss' mini-budget, which included unfunded tax cuts in 2022 that hit bonds and forced the Bank of England to cut… . To intervene to stabilize the markets.
On Friday, Finance Minister Bruno Le Maire, urging voters to support Macron's centrist candidates, warned of the risk of a financial crisis if the far right or left wins the elections.
The cost of insuring France's debt against default jumped on Friday to its highest level since May 2020, while an extension of high borrowing costs hit banks.
Shares in the country's three largest companies – BNP Paribas (OTC:), Credit Agricole (OTC:) and Société Générale (OTC:) – lost between 12 and 16% this week, the biggest loss since the March 2023 banking crisis. They were all down at least 4% on Friday.
In an illustration of how market turmoil is already affecting financing plans, a French state-backed 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 accounts?
Analysts often call bond investors “vigilantes” because of their demand for higher returns from governments they consider fiscally reckless.
“We've already had a stress test in the UK in terms of the mini-budget, and we had a bit last summer in the US when Treasury yields rose sharply after the Treasuries recovery announcement,” said Guillermo Felicis, global investment strategist at PGIM Fixed Income.
“We have not seen this yet in the eurozone.”
The Montaigne Institute think tank has looked at the National Front's platform for the 2022 parliamentary elections, saying it would cost more than €100 billion – suggesting a 3.5 percentage point increase in France's budget deficit – if passed in full. This is much higher than estimates for the Truss tax cuts.
RN party leader Jordan Bardella said on Friday that the party would present details of its program in the coming days and how to finance it. He has so far been vague about his stance on fiscal responsibility other than blaming the outgoing government for straining public finances.
“In an extreme case, risks could include a Les Truss-style explosion in yield spreads,” Holger Schmieding, chief economist at Berenberg Private Bank, said earlier this week.
Britain's 10-year bond yield jumped more than 100 basis points in less than a week during its budget crisis, while French bond yields rose just 6 basis points this week.
There were some early signs that concerns about France may spread to the eurozone.
Italy's closely watched risk premium compared to Germany rose to its highest level since February at 159 basis points on Friday.
Last year, Italy recorded the highest ratio of budget deficit to GDP in the European Union, at 7.4% of output. It is expected that it will face, along with France, the excessive deficit measures imposed by the European Union, which require it to reduce its structural deficit.
The euro recorded its lowest level in a month and a half against the dollar on Friday, and euro zone bank shares fell about 10% this week.
The bloc's financial structure is seen as much stronger than the debt crisis of more than a decade ago, with the European Central Bank repeatedly showing that it will intervene with new tools to stabilize markets in times of crisis.
However, Patrick Sanner, head of macro strategy at Swiss Re (OTC:) noted that the support tool used by the ECB to buy government bonds if justified requires compliance with EU financial rules for eligibility.
“This could create some doubts about the ECB's support,” he said.
Others said it was not yet clear how a potential government in France that included the National Front would work. Italy's debt outperformed last year, helped by far-right Prime Minister Giorgia Meloni, who has softened her tone in office.
Ian Steele, chief investment officer for international fixed income at JPMorgan Asset Management, said the UK's spending plans would be curbed by EU deficit rules.
“The market will also be a major force in keeping the National Rally Party in check, and the party is likely to take a more prudent financial position ahead of the 2027 presidential elections,” he added.