France is facing a critical budget battle that could destabilize the government, as the country’s borrowing costs soar. The yield on 10-year French government bonds has surpassed 4.5%, a level not seen since 2008, reflecting investor concerns over the nation’s ballooning debt and deficit.
Prime Minister Sébastien Lecornu’s administration is preparing to present a budget aimed at significant spending cuts, but political divisions and upcoming elections cast a shadow over its passage. Market watchers fear that the fiscal negotiations could trigger political chaos and further government instability.
- French lawmakers are tasked with agreeing on a budget by early October that can help slash the country's huge national deficit.
- Previous budget negotiations have sparked political chaos in Paris — and market watchers fear this year's talks could topple the current government.
- Time is not on the side of French government bonds, strategists have warned.
France is grappling with escalating borrowing costs as investors anticipate another tumultuous budget season. The nation's 10-year government bond yields, known as OATs, have surged past 4.5% for the first time since 2008, signaling a heightened risk premium demanded by the market. This surge places France's yield significantly higher than that of German 10-year bonds, a divergence not seen since the height of the euro zone sovereign debt crisis in 2012. Even Italy and Greece, often considered fiscal laggards, are now borrowing at lower rates than France.
The country's borrowing costs across the yield curve are among the highest in the G7, reflecting growing investor apprehension about its fiscal health.
Prime Minister Sébastien Lecornu's administration, operating with a fragile minority, is set to present the 2027 budget proposal to parliament in early October. The proposal, slated for a vote on November 17, aims to implement approximately 54 billion euros ($61.8 billion) in spending cuts to tackle France's burgeoning debt and a significant budget deficit. Economists warn that France is on an unsustainable fiscal trajectory, a concern amplified by Fitch's credit rating downgrade last year.
Official projections indicate that France's national debt will reach a record 119.3% of its gross domestic product (GDP) in 2026, with a further increase to 121.7% in 2027. This fiscal pressure intensifies the political divisions within the National Assembly, which comprises the far-right National Rally, the left-wing New Popular Front, and Lecornu's center-right bloc. Previous budget negotiations have already led to no-confidence votes in December 2024 and September 2025, and the 2026 budget was only passed using a constitutional clause to bypass parliamentary debate.
Analysts predict that the upcoming budget, even with proposed austerity measures, could trigger another government crisis. "A tough draft budget for 2027 risks toppling the government despite a widely held desire to avoid a political crisis before the presidential election next spring," noted Mujtaba Rahman, managing director for Europe at Eurasia Group. Lecornu appears determined to push through a budget that begins the process of fiscal consolidation, potentially through parliamentary compromise or the use of special constitutional powers.
Strategists at ING warn that "time is not in favour of French bond spreads," citing the upcoming presidential elections and potential subsequent legislative elections as further sources of instability. They forecast the spread between French and German borrowing costs to remain elevated in the coming months. The European Central Bank is unlikely to intervene to narrow this gap, prioritizing its fight against inflation. HSBC strategist Chris Attfield noted that while the current spread movement is significant, the ECB would likely only step in if market volatility becomes "disorderly." A key concern is the increasing non-domestic ownership of French bonds, raising questions about who would absorb selling pressure if these investors divest.
Despite the challenges, Lars Machenil, CFO at BNP Paribas, emphasized the importance of addressing France's debt. He expressed optimism that lawmakers would work towards an effective budget, stating, "I don't have a crystal ball, but what I see is that there is a willingness to get this over [the line]."
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'Time is not in favor' of French bonds
The government's push to reduce the budget deficit from an anticipated 5.4% this year to 5% faces significant political opposition. ING rates strategists Benjamin Schroeder and Michiel Tukker highlighted that beyond the current budget cycle, the focus will shift to the presidential elections, potentially followed by legislative elections and further government formation challenges. They project that the OAT-Bund spread will persist between 100 and 125 basis points in the coming months, with the ECB hesitant to intervene due to inflation concerns.
Chris Attfield of HSBC commented on the OAT-Bund spread's significant movement, suggesting that while it exceeds expectations given France's debt-to-GDP ratio, the ECB would likely only act in case of "disorderly" market conditions. He pointed out the growing proportion of non-domestic holders of OATs, posing a question about market liquidity and the potential price impact of any sell-offs.
BNP Paribas CFO Lars Machenil acknowledged the necessity of deficit reduction but stressed the need for a well-considered budget. "We'll see. But if you see the progress, if you see the timing, things are progressing well," he remarked on the prospects of timely budget approval.
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Speaking to CNBC's Karen Tso, Lars Machenil, chief financial officer at BNP Paribas, stressed the importance of fiscal discipline for France but also advocated for a well-thought-out budget. He conveyed a sense of cautious optimism about the budget's approval, noting progress and timing, while acknowledging the inherent uncertainties.
