Open this photo in gallery:
French President Emmanuel Macron attends a ceremony at the Mont Valérien memorial in Suresnes, a suburb of Paris, on June 18. LUDOVIC MARIN/Getty Images
It's never a good sign when a central bank has to publicly assure markets that it is closely monitoring the situation, but European Central Bank officials did just that on Monday amid growing fears that France was heading toward a Liz Truss affair.
Truss's 2022 term as UK chancellor was record-short, but it was marked by the Bank of England's unprecedented intervention in financial markets after the government delivered a recklessly mini-budget that included tens of billions of pounds of unfunded tax cuts. The bank was forced to promise to buy unlimited amounts of UK government bonds to stem a market sell-off that pushed the pound to its lowest level ever against the US dollar.
Fast forward to last week, when French President Emmanuel Macron suddenly called parliamentary elections. The Paris stock market crashed and the gap between French and German bond yields soared as investors worried that Macron's political gamble could lead to financial turmoil if the far-right Rally National or the left-leaning New Popular Front won the most of the 577 seats in the National Assembly on July 7.
The timing of the vote couldn't be worse: France was downgraded by S&P Global Ratings last month and is struggling with an unmanageable budget deficit that could reach 5.5% of gross domestic product in 2023. The election of a far-right or far-left government or a hanging parliament, where no party or coalition has a majority, could now deepen the country's fiscal difficulties.
Explained: How are French parliamentary elections conducted?
The Paris Stock Exchange's main stock index, the CAC 40, fell more than 6% last week, with shares in France's biggest banks dropping by double digits. French banks are the largest holders of French government bonds (OATs), and their spreads over German government bonds widened to their highest since 2017.
BNP Paribas, Societe Generale and Credit Agricole are considered globally systemically important banks (GSIBs) by the International Financial Stability Board, raising the risk of market contagion if they face liquidity problems. French banks are already facing rising funding costs due to concerns over the outcome of the French parliament's vote.
Macron, whose second and final presidential term ends in 2027, called for early voting in the country after his National Rally party came in first in the European Union elections on June 9. But if Macron was hoping that voters from all walks of life who oppose his party would rally together to stop the far-right party from winning parliamentary elections, he has so far sadly been wrong.
According to opinion polls, the National Rally currently enjoys the support of about a third of French voters ahead of the first round on June 30. Meanwhile, the New Popular Front, a four-party progressive coalition led by the far-left Invincible France party, has around 28% support. Macron's centrist coalition has less than 20% support. The top two parties as of June 30 will advance to the second round on July 7.
“It will never be clear what Macron was thinking when he called these elections, and the speed at which events have moved against him since June 9 is astonishing,” TD Securities said in a note on Monday.
“The shift in support at the polls from the protest vote in the EU elections to the French parliamentary elections [National Rally] There is increased uncertainty about the final outcome.”
European Central Bank chief economist Philip Lane tried to reassure investors on Monday, saying “what we are seeing in markets is a repricing, but we are not in a world of disorderly market movements that creates a series of traps for the transmission of monetary policy.”
European Central Bank (ECB) President Christine Lagarde also commented, “My obsessive goal is to return inflation to our 2 percent target over the medium term. Price stability goes hand in hand with financial stability, so we are paying close attention to the proper functioning of financial markets.”
Still, financial analysts openly speculating about possible ECB intervention in bond markets similar to the Bank of England's move in 2022 is deepening investor anxiety ahead of a make-or-break election.
The Rally is currently sticking to its promise to repeal Macron's pension reform plan (which would raise the pension age from 62 to 64) in 2023, but has not backed down on other flagship spending pledges, such as a promise to cut value-added taxes on fossil fuels and electricity from 20% to 5.5%.
The New Popular Front has pledged to reverse pension reforms within 15 days of taking power, after which the retirement age will be lowered to 60. It also plans to raise the minimum wage and reinstate a wealth tax on financial assets scrapped by Macron.
The European Commission is expected to impose sanctions on France on Wednesday for violating EU budget rules limiting the budget deficit to 3% of GDP. The measures would subject France to an “excessive deficit procedure” and require it to submit a plan to reduce its deficit.
Both the National Rally and the New Popular Front have said they will refuse to comply with EU budget dictates, and Liz Truss' performance in France may make the UK look compliant.
