France’s economy faces a key risk beyond its political turmoil

Published Thu, Sep 11 20251:05 AM EDTUpdated Thu, Sep 11 20253:52 AM EDT

Key Points

The French bond market has been subdued amid a political overhaul this week, but a significant risk lies in a series of upcoming credit rating updates.
Investors are already concerned about the country's fiscal trajectory, and the loss of its "double A" status could spark an outflow of institutional holders of its debt in Asia.
While the chance of a "catastrophic market event" or "doom loop" remains low, according to economists, higher yields could put even more pressure on France's growth outlook and force more painful fiscal measures in future.

France has already seen its prime minister voted out by lawmakers and a successor installed , followed by nationwide protests this week. Investor attention now turns to a closely-watched gauge of the country's economic condition: the first in a series of credit rating updates, which assess the risk associated with investing in a nation's debt. Downgrades could have series knock-on effects on French borrowing costs, as measured by the yield on its government bonds, economists warn. Of the big three ratings agencies, Fitch will kick off with its update on Friday, followed by Moody's on Oct. 24, and Standard and Poor's (S & P) on Nov. 28. Those come with France's debt load already firmly in focus. Since last summer's parliamentary election failed to deliver a majority to any one party or bloc, two governments have collapsed amid dispute over the coming year's budget — reigniting concerns the country is on an unsustainable fiscal track. France's public deficit hit 5.8% of gross domestic product in 2024 , the highest level in the euro zone. Major questions remain over how new Prime Minister Sébastien Lecornu will proceed, and whether he sticks with predecessor Francois Bayrou's proposals for 44 billion euros ($51.5 billion) in spending cuts and tax hikes — which included unpopular measures to scrap two public holidays, freeze pensions and welfare benefits and reduce local government funding. Agencies are meanwhile weighing up whether to raise, hold or lower their ratings from the spring , after several put the country on negative outlook but maintained its "double A" status , indicating low credit risk and keeping it well within investment grade boundaries. "If France does lose the coveted double A rating, it will have serious implications to institutional [bond] holders," Mohit Kumar, chief financial economist for Europe at Jefferies, told CNBC's "Europe Early Edition." "French debt is very much in demand from institutional holders, particularly from Asia, but they have quite strict criteria of holding double A debt," he continued. A scenario in which political turmoil drags on for more than three to six months and rating agencies downgrade the country would be a "worst case scenario for French debt," Kumar said. Bond market selling pushes yields — the amount paid out to investors — higher, which has knock-on negative consequences for the economy as it makes it harder to service existing debt and fund future growth. 'Close call' French borrowing cost moves have remained relatively subdued this week, with many of the latest political developments broadly expected by the market. The yields on 2-year , 10-year and 30-year bonds remain below both recent and historic highs despite the uncertain outlook. Some sovereign rating downgrade risk is already priced into the bond market, Deutsche Bank economists said in a Tuesday note, adding that the ratings update would be a "close call." "A move to single-A would be unlikely on its own to trigger forced selling, if this change is applied by only one of the rating agencies," they said. However, they continued that the backdrop was "unfavorable" given France's deficit overshoot, political uncertainty and need for fiscal consolidation, and despite some potential spillover benefits in the coming year from higher regional defense spending and a German fiscal expansion. In the near-term, Deutsche Bank said the latest turmoil could see individuals and businesses delay spending and investing, putting further pressure on the economy. Berenberg's Chief Economist Holger Schmieding said Tuesday that ratings downgrades were "possible" but would "not come as a major surprise." "A genuine financial crisis with a self-reinforcing doom loop (higher yields = bigger deficits = even higher yields) remains quite unlikely for the time being. With its almost balanced current account, France is no obvious candidate for a financial crisis," Schmieding said in a note. "Of course, we cannot rule it out completely," he added. The highest-risk situation for bonds would come in the event of snap parliamentary elections in which either the far-right National Rally or the French Socialists gain power, Schmieding said. "If the radicals then try to implement an unfinanceable agenda, bond investors may finally refuse to fund France," he said, which could in turn force a pivot toward fiscal prudence. Some protection from a crisis scenario that could cause contagion among the wider euro area is provided by the European Central Bank, said George Lagarias, chief economist at Forvis Mazars. "We would not be overly worried about a catastrophic market event, as the ECB, which is headed by a French former Finance Minister will more than likely step up to improve demand where that is lagging and borrowing rates spike," he told CNBC by email. "However, the ECB alone can't fix the French economy. At some point in the near future, a government will likely be compelled to impose unpopular austerity measures and address the deficits in the pension system. So while we believe that the ECB will likely smooth shorter-term market gyrations, markets may still force France into a more painful fiscal adjustment."