Following the weekend European elections, the French government bond market experienced significant stress. The 10-year OAT-Bund spread widened by 7-8 basis points, marking its highest levels since last year. The downgrade of France’s sovereign credit rating by Standard & Poor’s to AA- from AA due to budgetary concerns has further exacerbated the situation. This downgrade was a result of last year’s larger-than-expected budget deficit of 5.5% of GDP, linked to weak growth and soft revenues.
Potential Consequences and Future Outlook
With economists from ING anticipating the initiation of the Excessive Deficit Procedure by the European Commission against France on June 19, the possible repercussions for the euro are significant. The response of France’s next government to this procedure will be critical. As opinion polls hint at Marine Le Pen’s RN party potentially securing the largest vote share in the upcoming elections but falling short of an absolute majority, focus is likely to shift to potential coalitions and their policy implications. In this uncertain climate, the euro may struggle to rally and is forecasted to remain around the 1.07/08 mark, with downside risks.
Impact on the Eurozone and ECB Response
Eurozone speakers, including European Central Bank Chief Economist Philip Lane, are scheduled to address the situation. Despite the ECB’s hesitation to commit to further easing measures, with 31 basis points of easing already priced in for the year, the central bank may take a strict stance in the short term to counterbalance the potential impact of a weakening euro on disinflation. The EUR/USD exchange rate is currently encountering resistance at the 1.0800 level, reflecting market concerns over the blend of political and fiscal uncertainties in France.
The fallout of the European elections on the French bond market has raised concerns about the country’s fiscal trajectory and overall economic stability. The widening OAT-Bund spread and the impending Excessive Deficit Procedure by the European Commission highlight the challenges ahead for France. The response of the next government, along with the potential shift in coalition dynamics, will play a vital role in determining the market’s future direction. As the eurozone grapples with these uncertainties, the euro’s performance and the ECB’s response remain crucial factors to monitor in the coming days and weeks.