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Summary
Political gridlock and concerns over France’s public finances have pushed its borrowing costs sharply higher relative to Germany’s. In the latest blog, from Portfolio Manager, Sacha Chorley, explains why investors are questioning the credibility of France’s budget plans, how its ageing population and pension commitments are adding pressure, and why this remains a country-specific risk rather than a repeat of the Eurozone debt crisis, for now.
You would think that politicians would learn! The bond market was just getting worried about the gilt market and the prospect of a more fiscally loose Burnham government. And now, attention has shifted to French government bonds and the explosion in yields (relative to German bonds). It’s worth trying to understand what has happened and what this means: both for Eurozone, but also for government finances more broadly.
Good Moaning, Paris
Now to his credit, French Prime Minister Sebastien Lecornu did propose his 2027 budget, and within it attempted to generate around €54bn of savings — a mix of spending restraint and a handful of revenue-raising measures, including roughly €5.5bn from pension-related changes. On the face of it, this does not sound like the act of a spend crazed politician trying to buy their next votes. But in reality, it is the opposition parties that hold the balance of power given the fragmented parliament and they have already signalled resistance. Meanwhile, economists generally argue that the plan still falls well short of what's needed to stabilise a debt pile exceeding 115% of GDP against a deficit running above 5%.
This combination of ‘not good enough’ for either voters, opposing politicians or economists has been easily detected by bond investors. The spread between French and German 10-year yields (aka the OAT-Bund spread) has blown out past 140 basis points this week, wider than in the 2011-12 Eurozone debt crisis. Markets are basically pricing in a real probability that the political process drags on, the budget gets watered down further or rejected outright, and France ends up either with another caretaker government or a fiscal position that keeps drifting the wrong way.
What a Mistake-a to Make-a
France is a useful lens on a theme playing out globally: years of post-pandemic spending expansion are colliding with a growth backdrop that doesn't support the debt built up to fund it. Markets spent many years absorbing debt relatively cheaply. With rates much higher, and substantial, but high-quality credit issuance from AI companies giving buyers a strong investment, governments are needing to be much more credible with their own fiscal plans to ensure they remain attractive to bond investors. France, unfortunately, is currently struggling with this.
As a small aside, part of why French bond price action has been so sharp is the shape of its own investor base. Roughly half of French government debt is held by foreign investors, a much higher share than in Germany, the US, or even Italy. Hedge funds have been heavily involved in trading volumes too and that ends up with a market structure built for speed in both directions: it absorbed debt efficiently on the way up, but it can also reprice very quickly when sentiment turns, because there isn't a large, patient, domestically anchored buyer base to lean against it.
Does nobody hear the cries of a poor old woman?
Buried in the French budget detail is a proposal to only partially uprate pensions above a certain threshold in line with inflation, rather than fully indexing them, a change which is expected to save in the region of €6bn a year. This follows the government's decision last year to suspend the unpopular 2023 reform that was gradually raising the state pension age from 62 to 64 (!). Put those two things together and you can see the government is in a sticky spot.
Maybe this sounds familiar? It should! Our triple lock debate is basically the same underlying problem with a slightly different formula. Ultimately the issue is that a state pension promise designed decades ago is being tested by people simply living much longer than the system assumed. Systems built when a 65-year-old might expect 15-20 years in retirement are now supporting 25-30-year retirements, funded on a shrinking working-age base. France is choosing to erode indexation generosity rather than raise the retirement age further, for now.
It Is I, Lagarde
But it's not (yet) a rerun of 2012. Today, the President Lagarde at the ECB has more tools. The Transmission Protection Instrument, created in 2022, allows unlimited bond purchases to counter "unwarranted, disorderly" moves in a member state's borrowing costs. But it comes with conditions of course, and current France is currently in breach of EU mandated deficit levels which muddies its eligibility and makes activation legally and politically contentious.
Also, we have seen from other countries, that a changing fiscal stance is possible! The countries that were genuinely at the pointy end of the last Eurozone crisis have, pretty much sorted themselves out. Greece's debt-to-GDP ratio has fallen from a crisis peak of over 200% in 2020 to roughly 140% today, helped by consistent primary surpluses and early debt repayments, and its credit rating has been upgraded repeatedly, moving it back into solid investment-grade territory. Italy's debt ratio is drifting slightly higher again, but ratings agencies have upgraded it too, largely on the back of atypical political stability and a credible reform narrative.
For portfolios then, the sensible course of action is neither panic nor complacency. Right now, this looks like a genuinely idiosyncratic French story rather than the start of a broader Eurozone repricing. As we would expect a little more political risk over the next few months, it might not be the time to jump into French bonds with two feet. Instead, as promised at the top: we shall say this only once. Watch the budget vote.
Key takeaways
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Fiscal credibility matters - France’s high debt, large deficit and divided parliament are making it harder to deliver convincing budget reforms, prompting bond investors to demand higher returns.
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Long-term pressures are building - Pension commitments and longer retirements are placing growing strain on public finances, a challenge shared by the UK and other developed economies.
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France looks contained for now - The ECB has tools to respond to disorderly markets, and other Eurozone countries have strengthened their positions. However, investors should remain alert to political developments and the budget vote.
Sacha Chorley
Portfolio ManagerSacha is a portfolio manager of the Quilter Investors Cirilium and Creation Portfolios. Prior to joining Quilter Investors in 2011, Sacha worked at Broadstone with their team of economists before moving into asset allocation and fund manager research.
Sacha is a CFA charterholder and has also completed the Chartered Alternative Investment Analyst qualification. Sacha has a degree in Maths from the University of Bath.
