France bond spread widens as budget strain lifts borrowing risk premium

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France bond spread widens

Highlights

France's 10-year bond spread over Germany has climbed to 104 basis points, doubling since the 2024 snap election amid fiscal and political pressures.
Deficit reduction plans face opposition as France is set to miss its 5% deficit target for 2024, with debt-servicing costs 4.5 billion euros higher this year and 10 billion euros higher next year.
Investor concerns over the 2025 presidential election and weak growth have pushed France's risk premium above Italy's, eroding its traditional euro-zone safe-haven status.

Fiscal pressures and market repricing

As reported by Reuters, France now pays a 104-basis-point premium on its 10-year bonds over Germany, after its borrowing costs rise faster than those of other developed economies during a recent global bond selloff driven in part by higher energy prices and inflation concerns.

The gap has doubled since a snap election in 2024 produced a fractured parliament, making it harder to cut the budget deficit. The government is trying to reduce the deficit from 5.4% of output this year to 5% next year through 54 billion euros of spending cuts, but opposition parties are likely to challenge those plans in coming months, creating a risk of political instability.

France is also set to miss its original 5% deficit target for this year because growth is weaker than expected. Rising energy prices linked to the Middle East conflict are also increasing concerns that further European Central Bank rate hikes could weigh on growth and worsen the fiscal outlook.

Election risks and broader euro zone impact

Investor concern is mounting that next year's presidential election could derail efforts to lower the deficit, with Marine Le Pen on the far right and Jean-Luc Melenchon on the far left leading the field. Melenchon's call for the French central bank to cancel government debt it holds has unsettled investors, while Le Pen is advocating a lower retirement age for some people, adding to worries about future spending pressure.

Higher borrowing costs are making new debt issuance more expensive and are adding to debt-servicing costs, already France's biggest budget expense as it refinances large amounts of COVID-era debt raised at ultra-low rates. The government expects debt-servicing costs to be 4.5 billion euros higher than expected this year and another 10 billion euros higher next year.

Economists warn that weak growth and rising rates raise the risk of a snowball effect in which borrowing costs keep climbing unless France achieves a primary surplus, which remains distant. France is even paying a higher premium than Italy, despite Italy carrying higher debt and lower credit ratings, a sign that the euro zone's largest bond market is losing some of its traditional safe-haven status.

David Zahn, head of European fixed income at Franklin Templeton, says a 100-basis-point spread over Germany shows France has real problems that are unlikely to be solved soon. Some analysts see limited room for a sharp further rise in the near term after the recent move, but they say more political turmoil, including a government collapse or a Le Pen-Melenchon runoff, could still push the spread wider, with Societe Generale not ruling out 120 basis points.

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