France enters its most consequential budget season in years with a hung parliament, a deficit stuck above 5% of GDP and a presidential election that could bring either a hard-left or far-right leader to the Élysée. The combination has pushed French borrowing costs above Italy's for the first time since the eurozone crisis, even though Rome carries a substantially heavier debt burden. Investors are no longer waiting for a crisis to price in French political risk; they are doing it now.
Bond markets price in a new risk premium
The spread between French and German ten-year bonds widened to its highest level since 2024 this week, a move that reflects more than routine seasonal illiquidity. French yields now sit above Italian ones, a striking inversion given that Italy's debt-to-GDP ratio exceeds 140% against France's roughly 110%. The market is signalling that political unpredictability in Paris is now seen as a greater threat to creditors than the sheer stock of debt in Rome.
That judgement fell hardest on French banks. European Central Bank supervision means lenders hold large portfolios of sovereign debt, so a rise in French yields hits their capital directly. Crédit Agricole and BNP Paribas dropped between 3.3% and 4.3% on Thursday, among the weakest performers on the CAC 40. The sell-off underscores how quickly sovereign stress transmits to the domestic financial sector in a monetary union without a common fiscal backstop.
A deficit that refuses to shrink
The numbers are stubborn. France recorded a deficit of 5.1% of GDP in 2024, one of the highest in the eurozone. The government's target for this year is a modest 5.0%, a reduction so slight it barely registers. Achieving even that has proven difficult: the minority government of Michel Barnier, and before him Gabriel Attal, both fell after failing to secure parliamentary backing for fiscal measures. The 2027 target of bringing the deficit below the EU's 3% ceiling looks increasingly theoretical.
Compounding the problem is a refinancing wall. Hundreds of billions of euros in bonds issued at near-zero rates during the pandemic must be rolled over in the next five years at today's significantly higher yields. Every tenth of a percentage point in the spread adds billions to annual interest costs, crowding out the very public investment, green transition, defence, digital infrastructure, that both Brussels and Paris say they want.
The election that shapes the budget
The presidential election scheduled for spring 2027 is not a distant backdrop; it is the primary driver of current fiscal paralysis. A Harris Toluna poll published this week found that in four out of five scenarios, the runoff would pit Jean-Luc Mélenchon of La France Insoumise against Marine Le Pen of the Rassemblement National. The poll showed Le Pen winning comfortably against all tested opponents, though French presidential elections have a long history of late surprises.
Both candidates propose policies that would expand the deficit dramatically. Mélenchon has called for the cancellation of French government debt held by the European Central Bank, a move that would effectively monetise fiscal policy and violate the EU treaties. Le Pen advocates lowering the retirement age to 60 for workers who started young, reversing the 2023 reform that raised it to 64 and adding tens of billions to annual pension costs. Neither has presented a credible financing plan.
"There's a lot of unknowns, but in general, it seems like they will all want to ease fiscal policy," said David Zahn, head of European fixed income at Franklin Templeton, which manages roughly $1.8 trillion. "There's nobody coming in on a policy that we need to fix the budget deficit, we need to bring the debt down." That assessment, shared across trading desks in London, Frankfurt and Paris, explains why the risk premium is rising before a single vote has been cast.
Rating agencies circle
Fitch Ratings is due to publish its latest assessment of France on Friday, the first of the major agencies to review the sovereign this cycle. A year ago Fitch downgraded France to A+, a record low for the country, citing deteriorating public finances and political fragmentation. Moody's and S&P Global Ratings will follow in the coming weeks. A further downgrade would push France into single-A territory across the board, triggering mandatory selling by some institutional funds and raising collateral requirements for French bonds in repo markets.
The agencies have been notably patient. France has missed its own deficit targets repeatedly since the pandemic, and the European Commission has opened an excessive deficit procedure. Yet the ratings have held, partly because the agencies assume that EU fiscal rules and market discipline will eventually force adjustment. That assumption is now being tested by a political class that shows little appetite for the required measures.
The institutional trap
France's constitution gives the president powerful tools, Article 49.3 allows a government to pass a budget without a vote, subject to a confidence motion, but using them repeatedly erodes legitimacy. The current government, a fragile coalition of centrists and centre-right deputies, survives only because the left and right have not united to topple it. That paralysis suits no one: the left wants higher spending, the right wants tax cuts, and the centre wants deficit reduction. None has the numbers to impose its will.
The European Commission's revised fiscal framework, agreed in 2024, was supposed to provide a credible path. It requires countries with excessive deficits to submit adjustment plans spanning four to seven years. France's plan, submitted earlier this year, relies on optimistic growth assumptions and unspecified "structural measures" after 2026. The Commission accepted it with reservations. Markets have not.
No consensus on the cure
Economists agree on the diagnosis: France spends 58% of GDP, the highest in the OECD, while collecting 48% in revenue. The gap is structural, not cyclical. But the prescription divides the political spectrum. The right argues for spending cuts, particularly in the sprawling local administration and overlapping social benefits. The left demands higher taxes on wealth and corporate profits. The centre, which has governed for seven years, has tried both at the margins and achieved neither.
"I'm very pessimistic about the ability of either the current president or the next one to deliver the structural reforms needed to reduce the fiscal deficit," said Christopher Dembik, senior investment adviser at Swiss private bank Pictet. His view reflects a broader scepticism among international investors who have watched French governments promise consolidation and deliver stability laws that are watered down or abandoned at the first sign of street protest.
The ECB's quiet dilemma
The European Central Bank watches from Frankfurt with limited options. Its transmission protection instrument (TPI) can be activated to cap spreads for a country that meets fiscal and macroeconomic conditions. France currently does not meet them: it is in excessive deficit procedure, its debt is rising, and its adjustment plan is judged insufficient. Activating TPI for France would be politically explosive in Germany and the Netherlands, where any perception of monetary financing is anathema.
Yet allowing French spreads to widen unchecked risks fragmentation of monetary policy, tighter financial conditions in Paris than in Berlin despite a single interest rate. The ECB's portfolio of French bonds, accumulated under the pandemic emergency purchase programme and the asset purchase programme, already sits at over €500 billion. Unrealised losses on those holdings are substantial. The central bank has a direct financial interest in French fiscal credibility, but no leverage to enforce it.
People mentioned
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Christopher Dembik
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David Zahn
Organisations
European Central Bank · Fitch Ratings · Franklin Templeton · Pictet · Crédit Agricole · BNP Paribas
