Victory for French far right could trigger Liz Truss-style debt crisis, warns finance minister

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France’s finance minister has warned that the country could face a debt crisis akin to the UK’s gilt market turmoil under former prime minister Liz Truss if the far-right Rassemblement National wins snap elections this month and next.

In a sign of market nerves, French government bonds have sold off sharply since President Emmanuel Macron’s shock announcement on Sunday that he would dissolve parliament and call fresh elections after his party was routed by the far right in European elections.

The sell-off has pushed the gap between French and German borrowing costs to its highest level since October. The cost of some maturities of French debt has also risen above those of Portugal, which defaulted during the Eurozone crisis and had a junk credit rating for much of the past decade.

“If the RN implements its programme, a debt crisis is possible. A Liz Truss-style scenario is possible,” finance minister Bruno Le Maire told local party officials on Tuesday night.

A crisis erupted in the UK bond market in 2022 when Truss put forward a Budget that would have implemented tens of billions of pounds worth of unfunded tax cuts. Truss was forced to resign after only 44 days in office, but not before the crisis had knocked hundreds of billions of pounds off the value of UK pension schemes.

Le Maire warned that France “simply [does] not have the means to finance [RN leader] Marine Le Pen’s additional tens of billions of euros” in costs associated with the party’s agenda to cut sales taxes and raise the retirement age.

The yield on benchmark 10-year French bonds rose as much as 0.22 percentage points on Monday and Tuesday to more than 3.33 per cent at one stage, pushing the premium on France’s borrowing costs over Germany’s to 0.62 percentage points. 

French bonds later partially reversed losses to trade at a yield of 3.25 per cent on Wednesday. However, investors remain concerned that, should the RN take or share power, its plans for tens of billions of euros of extra public spending could prevent any improvements in the country’s yawning budget deficit.

François Villeroy de Galhau, governor of the Bank of France, on Wednesday warned that the country needed to clarify its spending trajectory as soon as possible.

“It will be important that, whatever the outcome of the vote, France can quickly clarify its economic strategy and in particular its budgetary strategy,” he told Radio Classique on Wednesday morning. “Electoral periods are always accompanied by uncertainty . . . but investors do not like uncertainty.”

The heavy selling of French bonds this week follows rating agency S&P’s decision to lower its rating on French debt at the end of May to double A minus, pouring cold water on the French government’s efforts to improve its public finances. 

“When you look at French debt metrics the deficit is an issue and I think that, combined with political uncertainty, makes it no surprise that spreads have widened,” said Andrew Balls, chief investment officer for global fixed income at bond giant Pimco. Markets were “pricing the risk appropriately”.

France’s budget deficit was far above target at 5.5 per cent last year, which puts France on the EU’s excessive deficit procedure list. According to new EU rules that kick in next year, France will need to reduce its structural deficit by 0.5 per cent per year until the overall deficit comes below 3 per cent. 

The government has also pledged to bring the deficit below 3 per cent by 2027. Cedric Gemehl, analyst at Gavekal Research, said those plans “did not look credible to begin with” and “even less so now”, adding that “further downgrades look probable”. 

Jason Davis, global rates portfolio manager at JPMorgan Asset Management, said he has held a lower-than-benchmark weighting in French government bonds for some time. “The snap election increases uncertainty over the trajectory of France’s fiscal sustainability and subsequent credit ratings,” he said.

Still, France’s bond sell-off remains more muted than in 2017 when Le Pen finished second in the first round of voting for the French presidency, pushing the spread in borrowing costs between the Eurozone’s second-largest economy and Germany to 0.8 percentage points.

Since 2017, Le Pen has rowed back on her plans to pull France out of the EU. Analysts say that the widening of the spread this time should be less intense in the coming months, but warned that France’s presidential elections in 2027 could pose a bigger risk to markets should Le Pen remain far ahead in the polls.

“In a nutshell, the key issue for markets is the possible fiscal implications from a Le Pen majority rather than an existential one such as potential Frexit,” said Meera Chandan, global FX strategist at JPMorgan Chase. 

Additional reporting by Kate Duguid in New York