French markets hit by threat of government collapse

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French sovereign bonds and stocks fell on Wednesday as concerns intensified among investors that a dispute over a belt-tightening draft budget could bring down Prime Minister Michel Barnier’s government.

The sell-off pushed the gap between 10-year French borrowing costs and those of Germany to as high as 0.9 percentage points, a level not reached since the Eurozone crisis in 2012. It later fell back to 0.86 points.

The benchmark Cac 40 stock index fell 0.7 per cent, making it the worst performer among major European markets. Banks and insurers were hardest hit, with Axa down 4.3 per cent and Société Générale losing 3.5 per cent.

Barnier is seeking to pass a budget with €60bn of spending cuts and tax increases despite his lack of a working majority in parliament. He has confirmed he will have to use a constitutional tool to override lawmakers to do so, a move that will expose him to a no-confidence vote that could bring down his government along with its budget. 

“The sell-off is on fears over a potential collapse of the Barnier government,” said Gareth Hill, a bond fund manager at Royal London Asset Management. If the budget was not passed, the challenge of bringing France’s debt load down would become “even harder”, he added.

Far-right leader Marine Le Pen has emerged as a key player in the drama because her Rassemblement National party is the biggest in the lower house and its votes would be needed for a censure motion to pass. After meeting Barnier on Monday, Le Pen warned that the prime minister was not listening to her demands to protect the French public from tax rises and she reiterated a threat to bring down the government.

In an interview with French broadcaster TF1 on Tuesday, Barnier called on opposition parties to pass the budget, arguing that if it did not go through, there would be a “big storm and very serious turbulence on the financial markets”.

The standoff between Barnier and parliament could come to a head as early as next week with a vote on social spending, which could lead to a first no-confidence vote. Alternatively, the government could face a no-confidence vote in the days before Christmas. 

Against a backdrop of political instability, the sell-off in French government bonds has pushed the 10-year bond yield above 3 per cent, as investors worry about the sustainability of Paris’s debt load. Yields are now only marginally lower than those in Greece, the country at the heart of the sovereign debt crisis more than a decade ago.

France’s budget deficit is on track to exceed 6 per cent of GDP this year, more than double the EU’s target of 3 per cent.

Brussels has put France in an “excessive deficit” monitoring process to push it to cut deficits over a five-year period.

Barnier had promised to bring the deficit back to 5 per cent of GDP by the end of 2025 — a goal economists now see as unlikely — and to return to within EU limits by 2029.

“It is hard to be too optimistic on the trajectory for France,” said Mark Dowding, chief investment officer at RBC BlueBay Asset Management. “There is a risk that [government bonds] could see further selling pressure if the political backdrop deteriorates.”