Political Instability and Budget Tensions: France Worries Investors

Political instability and budget tensions are raising concerns among investors in France. Following the unexpected resignation of Prime Minister Sébastien Lecornu, fears about the political and fiscal situation in the country have heightened, impacting the Paris Stock Exchange and increasing the cost of debt.

On Monday, the Paris Stock Exchange closed down by 1.36%, and the interest rate on French ten-year bonds surged to 3.61% immediately after the resignation, before settling back to 3.57% by day’s end. The euro also weakened against the dollar.

Amid political deadlock, budget uncertainties, and market volatility, investors are facing growing concerns.

The Threat of Dissolution

There is a rising probability of the dissolution of the National Assembly, according to Philippe Cohen, a portfolio manager at Kiplink. Emmanuel Macron stated on Monday that he is prepared to "take responsibility" if Prime Minister Lecornu fails within the next 48 hours in his last-ditch negotiations.

Investors are particularly worried about the potential return of the left, which may reverse pension reforms and tax policies. The left is perceived as more spendthrift, thus less capable of managing France's debt, Cohen explained.

The Absence of a Budget

Cohen also pointed out uncertainty surrounding the funding of the 2026 budget, as markets dislike the unknown. Lecornu's resignation jeopardizes the presentation of a budget before October 13, making it more likely that a special law will be passed to allow the state to operate on a minimal basis.

On the debt market, the yield on French ten-year bonds exceeded 3.61% on Monday right after the resignation announcement, reaching its highest level since March, before dropping back to 3.57% by the end of the day. The spread, or the gap between French and German ten-year bond yields, has now reached 0.85 percentage points for the first time since January, up from around 0.50 percentage points before Macron's dissolution of the National Assembly in June 2024.

A Lingering Political Crisis

Lecornu's resignation highlights the "precarious nature of the French political system," noted Danni Hewson, head of financial analysis at AJ Bell. "The big question is what will happen next, as finding a viable solution—temporary or otherwise—has become increasingly difficult after five prime ministers in two years," he added.

In 2024, the National Assembly's dissolution cut the legs out from under the CAC 40, which had seen a 6% growth for the year before the announcement in June, ultimately declining by 2.15% for the year. Since then, the leading index has returned to historic highs and has started to catch up; currently, the CAC 40 is up about 8% for the year, in contrast to nearly 16% for London's FTSE 100 and 22% for Frankfurt's DAX.

A Safety Net

Observers note, however, that there is little risk of contagion from this domestic situation in France. "The French market is suffering from its internal politics," summarizes Cohen. "The sharp drop in French bank stocks, the decline of the euro, and the rise of spreads emphasize the weight of prolonged political paralysis. However, at this stage, the increase in spreads is not sufficient to trigger the ECB's TPI instrument," say analysts at Evercore ISI.

In case of tensions in the debt market, the ECB has in its arsenal an "Instrument for Protection of Transmission" (TPI), allowing it to purchase state debt securities whose yields rise too quickly compared to those of Germany. "The existence of this safety net continues to help contain" the rise in French debt yields, the analysts continue.