What is happening in France?
If you thought the UK's revolving door of Conservative Party leaders was fast-paced, France has taken it up a notch with three prime ministers in less than a year and a caretaker government holding the fort for 51 days (a new national record). While Britain may have mastered the art of the "resignation speech," France appears to be perfecting the "no-confidence coup," with political turnover so rapid it might soon be measured in RPMs — Revolutions Per Minister.
Going back to the beginning of the recent instability, in June 2024 President Macron dissolved the National Assembly and called for a snap election in a bid to counter the rising influence of the National Rally with the result being a hung parliament where no single majority or coalition government prevailed. Shortly after, in July 2024 Macron accepted the resignation of Prime Minister Attal with a “caretaker” government stepping in for 51 days before Barnier took over in September 2024. By early December, Barnier’s government was toppled by a no confidence vote, which has left France firmly in political turmoil.
Diverse opposition from both the right and the left wings of the political spectrum have made it difficult to create a secure and stable government despite repeated attempts throughout the year. This instability has played out against the backdrop of widespread public protests against proposed austerity measures, which further constrains the government’s ability to implement economic reforms.
As a result, France has seen waning investor confidence characterised by widening spreads on French government bonds compared to other European economies. The current spread between the French and German five-year bond is 55bps, up from 31bps at the start of the year but down from the high point of over 60bps earlier in December. Nonetheless, current spreads are well away from the long-term average of around 20bps. Additionally, France sovereign one-year Credit Default Swap spreads have increased 5bps from early June (although 1bp below their peak earlier this year) and individual French banking names have crept up over the last six months, diverging slightly from other European names albeit not particularly far.
What does this mean for the French economy? The longer the unstable political situation continues, the worse the damage and potential fallout will likely be. Until recently, France had managed to avoid any ratings downgrades despite the ongoing instability but on the 14th December Moody’s chose to reduce the long-term rating from Aa2 to Aa3 and revise the outlook to stable This was in light of the likelihood of weaker public finances in the coming years due to ongoing political fragmentation. Further downgrades are not impossible if the current situation remains for an extended period.
Despite the apparent doom and gloom the situation, to put this in perspective the French economy does have many strengths to offset the current weaknesses. The French economy is generally wealthy and well diversified, and is the 7th largest economy globally. Although the current situation is unprecedented, spreads on government bonds have narrowed in recent weeks and contagion risk to other European economies remains unlikely. Additionally, although there are medium-to-long term risks of ongoing government instability it is important to note that the short-term risk of default is very low.
That being said, there is only so much patience that bond markets have, and government debt costs are based on not just what governments do but what they say and how markets perceive them. Currently, confidence in the French political system is very low and although the situation as it stands is not dire, continued political fragmentation may lead to a negative feedback loop of increased borrowing costs and failures to meet fiscal targets, which in turn drives up borrowing cost.
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