Weighing up risks from heightened political uncertainty in France

• PM Lecornu’s resignation pushed France deeper into political crisis but President Macron has resisted calls for a snap election. Instead he will name yet another PM to try to navigate the mess. The suggestion is that the next government could be more neutral/technocratic in nature. A change in approach after the repeated failures previously could have some merit. But with no parliamentary majority in sight (and any snap election unlikely to change that) uncertainty will remain elevated. Policy drift and fiscal speculation will continue to weigh on activity. We see GDP growth at just 0.7% in 2026, a similar rate to this year.
• There is still a narrow path for a budget to be approved by year-end. Lecornu confirmed that a draft is set to be presented next week. We don’t see much scope for meaningful consolidation. The controversial pension reform is seemingly up for debate and any reversal would have a clear fiscal cost – but that may be seen as a price worth paying for a return to some political stability.
• Political uncertainty in France has contributed to more volatile price action in the French government bond market this week. Long-term yields were temporarily lifted up to highs over the past year, and the EUR’s upward trend has been dampened.
• A bigger sell-off for French government bonds and the EUR is likely to require fresh elections to be called. If political stability is restored without the need for fresh elections, the EUR is likely to resume its upward trend against the USD rising up towards our year end forecast of 1.2000.

Macro view: Uncertainty and policy drift to remain a drag

Macron is intent on muddling through the gridlock

Political uncertainty has weighed on the outlook for France ever since President Macron’s decision to call a snap election in June 2024 resulted in a split National Assembly. An autumn showdown was not exactly a shock given the requirement for tough fiscal action within that fragmented landscape (see here).

But the resignation of Lecornu as PM on Monday morning after 27 days in office (and just hours after announcing his cabinet choices) ensured that France moved firmly into political crisis territory. Lecornu blamed the parties’ lack of appetite for compromise amid positioning ahead of the next presidential election, which is due in 2027.  There was little change in approach from his side, however, with a majority of his cabinet picks having featured in the previous Bayrou government.

Lecornu’s resignation left President Macron with three broad options: (1) try to muddle through with another PM (possibly from the left or from a neutral, technocratic background), (2) call snap legislative elections, or (3) resign and trigger presidential elections.

For now, Macron is determined to continue to try to navigate the mess, despite losing support from various long-term allies and some of his previous PMs. He tasked Lecornu with a last-ditch attempt at bringing parties together to find a functioning government in the interest of stability. After two days of negotiations, Lecornu reported that Macron may be able to appoint a PM “within 48 hours” (i.e. by the evening of 10 October).

Parties’ focus on the bigger prize – the next presidential election – has been a significant factor behind France’s recent budget impasses. Every political decision has been framed through that lens. Opposition parties have attempted to walk a thin line between standing by their policy platforms and avoiding being seen as contributing to the current inertia and policy drift. Lecornu’s view is that the future government team should be “completely disconnected” from 2027 presidential ambitions, which seems to point to some sort of technocratic government. After the repeated failures previously, a change in approach seems overdue. It’s certainly plausible that a more technocratic figure, open to compromise and a slower pace of fiscal consolidation, could support some (relative) stability in France.

No guarantee that snap elections would fix the situation

A new PM, if appointed by Friday, will be the fourth in 10 months. This feels like a last roll of the dice for Macron. There would be huge pressure to call another snap legislative election if his efforts to cobble together a government and find support for a budget were to fail again. A snap election would be held 20-40 days after the National Assembly is dissolved and would take place over two rounds on consecutive Sundays.

It is far from clear that another election would solve anything. Polling hasn’t changed much relative to the 2024 election result. The centre right and to a lesser extent RN have gained support, and the centrist alliance and the left have slipped back slightly. Legislative elections in France are hard to predict given the possibility of cross-party agreements and shifts between the first and second rounds of voting. It’s also interesting to see some polling (e.g. here) which suggests that the French public may be somewhat less inclined to vote tactically to block RN. But still the overall picture from the polls is that no group would be close to a majority and so we assume that a snap election would result in another fragmented National Assembly.

No party or group in parliament is close to a majority

A snap election would likely see another hung parliament

Meanwhile, we still believe the likelihood of Macron stepping down as president (something he has previously ruled out) remains low, even if his next PM finds little success in navigating France’s divided parliament. Assuming that any snap election would return more fragmentation, that means that an extension of the current situation – i.e. policy drift under what is essentially a lame duck presidency – is our base scenario until the next presidential election. That’s clearly far from ideal – uncertainty and fiscal speculation are set to continue to weigh on sentiment and activity.

Fiscal slippage and a lack of clear growth drivers

Business sentiment was already looking weak even before Lecornu’s resignation. The composite PMI slipped to a five-month low of 48.1 in September. There are no obvious growth drivers for France. The need for fiscal consolidation remains, even if there is slippage next year, and both firms and consumers are likely to stay cautious. We had already factored in heightened political uncertainty into our latest forecasts and have below-consensus growth of just 0.7% in 2026, after a similar rate this year.

Meanwhile, France’s fiscal situation will continue to cast a long shadow. Before being ousted, previous PM Bayrou said that MPs did not have the “power to overthrow reality” and that France needed a plan to escape “the inexorable tide of debt”. That is certainly reflected in the numbers. Public debt is at 114% of GDP, from around 98% prior to the pandemic. France has not run a primary surplus since 2001, and the headline deficit has widened from 4.7% of GDP in 2022 to 5.8% last year. While the deficit remains on track to improve slightly to around 5.4% this year, the EU’s 3% limit remains a distant prospect. Fitch downgraded its rating for France by a notch (to AA-) on 12 September. Moody’s will review France on 24 October, and S&P on 28 November.

Business sentiment in France had already weakened before Lecornu’s resignation

The France-Germany 10Y spread approached this year’s highs

In terms of the 2026 budget, there is apparently still a path for one to be adopted by year-end, but it looks extremely narrow. Lecornu confirmed that a draft budget, which will “not be perfect” can still be presented on Monday 13 October, the last possible deadline to allow sufficient time for discussion and approval.

The controversial 2023 pension reform, which was pushed through without a parliamentary vote, will be up for debate. The reform includes a gradual increase in the retirement age, and stricter conditions around contributions and for early retirement in certain sectors. Lecornu said that there were “several problems” to be resolved on the issue. Any reversal would have a clear fiscal cost – but it may be judged a price worth paying if it can lead to more political stability.

If no agreement can be found then a special law would have to be approved to roll over the 2025 budget, at least temporarily, into next year, which would mean more fiscal slippage. Even if a path to a 2026 budget can be found, it’s hard to see scope for meaningful consolidation in the current parliament after the past failures. The Bayrou deficit target of 4.6% looks firmly out of reach (something around the 5% mark looks more likely to our minds).

In terms of the broader outlook, any new PM will face exactly the same parliamentary arithmetic as his or her predecessors. As noted above, a change in approach regarding the PM pick seems overdue. If Lecornu’s hint at a more technocratic government is right, it may prove to be a productive shift after the repeated failures of Macron’s political allies to navigate the mess. But any sort of truce will be inherently fragile and policy drift looks set to remain a feature of the French outlook over the medium term. The resultant drag on growth will only add to the challenges around putting public finances on a more sustainable footing.

Market Implications: Higher government borrowing costs

Further yield spread widening & EUR weakness to remain contained unless fresh elections called

The renewed pick-up in political uncertainty in France this week has triggered volatility in the French government bond market. At the start of the week, yields on the 10-year and 30-year French government bonds initially jumped higher by around 10bps and 12bps. It lifted the 10-year French government bond yield back to within touching distance of the year to date high from March at 3.63%. Given there was also a global sell-off in longer-term government bonds at the start of the week, the relative underperformance of French government bonds was better reflected by the yield spread between the French and German government bonds. The yield spread between 10-year French and German government bonds widened out by around 5 bps moving the spread closer to the widest point over the last year from in early December 2024 just before former Prime Minister Michel Barnier resigned on 5th December after his government lost a vote of no confidence. French government borrowing costs have even risen above those in Italy over the past month. 

However, the initial move higher for French government borrowing costs has quickly reversed. The yields on 10-year and 30-year French government bonds are now both trading back close to levels from the end of last week prior to the resignation from Prime Minister Lecornu on Monday. The price in action in the French government bond market indicates that the upward pressure on yields earlier this week was mainly driven by building investor concerns that President Macron could call fresh elections in France. However, those concerns have since eased after reports that President Macron is likely to appoint another Prime Minister by the end of this week with a preference for a technocrat. In addition, there have been indications that the next Prime Minister would be more open to compromise on scaling back fiscal consolidation measures including discussions over reversing pension reforms. While a budget with less fiscal consolidation would be helpful for political stability, it would be a negative development for France’s fiscal outlook. Without a majority in parliament in favour of significant fiscal consolidation, the government is likely to continue running elevated budget deficits ahead of the next scheduled Presidential election in 2027 remaining a headwind for the performance of  French government bonds.

French bond yields have risen above those in Italy

French political risk is dampening EUR’s upward trend

However, it is likely those downside risks are already reasonably well priced into French government bonds helping to curtail further weakness. The yield spread between 10-year French and German government bonds has been trading between 0.65% and 0.90% over the past year. The last time the spread traded above 1.00% was during the euro-zone debt crisis between 2011 and 2012 when fears were more prevalent over euro-zone countries potentially leaving the single currency (“redenomination risks”). As we are far from such extremes at present, it suggests there is a higher hurdle for yield spreads to widen significantly. To trigger a bigger sell-off in the French government bond market it would likely require President Macron to either call: i) snap parliamentary elections or ii) bring forward the timing of the Presidential election perhaps as part of a deal to pass next year’s budget.  

Looking back at monthly portfolio investment flows from Japan, one can see that Japanese investors were heavy sellers of French government bonds when domestic political risks picked up last year. Following the French parliamentary elections in June and July of last year, Japanese investors sold a net JPY4.73 trillion of French long-term debt securities between July 2024 and January 2025. The bulk of those sales were recorded in July, October and November of last year when political risk was more intense. Japanese investor demand for the French bonds had started to recover in the 1H of this year when net purchases totalled almost JPY900 billion in the four months to July. However, the recent renewed pick-up in political uncertainty is likely triggering some further selling of French bonds by Japanese investors.

Elsewhere, the negative spill-overs into the foreign exchange market have been modest so far although the EUR has underperformed this week as political risks in France have intensified. EUR/USD has dropped back to closer to the 1.1600-level after trading above the 1.1700-level last week. The pair is now approaching important support levels between 1.1500 and 1.1600 where it has been trading above since the middle of this year. A break below those levels would be a more bearish signal for the EUR opening the door for deeper correction lower heading into year end.

If fresh elections are avoided in France, we expect those levels to ultimately hold and for EUR/USD to rise back up towards our year end forecast of 1.2000. However, we acknowledge that it would be more challenging for the EUR to reach our forecast if President Macron called snap parliamentary elections before year end. In that scenario we expect EUR/USD to consolidate closer to current levels heading into year end as heightened political uncertainty in France provides more of an offset to the negative impact on the USD from further Fed rate cuts. The worst case scenario for the EUR would if President Macron brings forward the Presidential election which could trigger a deeper correction lower for EUR/USD and reversal of the bullish trend that has been in place this year.