France at a Crossroads: A Decisive Christmas for the Barnier Government

Will Michel Barnier's government survive Christmas?

This is the question stirring media and political circles for several days. Marine Le Pen, leader of the National Rally (far-right), has explicitly threatened to bring down the government if it resorts to Article 49-3 of the Constitution to pass the 2025 budget without a vote. This threat is based on the austerity measures announced by the executive, including a six-month postponement of the pension adjustment and the normalization of electricity taxes following the end of the energy price shield.

This statement triggered a shockwave in the bond market: the spread between French and German debt reached 84.1 basis points (0.841%), a record since the Eurozone crisis. This spread has now surpassed that of Greece (83.8 bp) and Spain (74 bp). Already weakened by the political instability caused by last summer's parliamentary dissolution, the French stock market is underperforming compared to its German counterpart. Another episode of political crisis, combined with the inability to pass a budget, could plunge the country into a financial crisis of unprecedented magnitude since the Eurozone crisis.

To make matters worse, the rating agency Standard & Poor’s is set to deliver its verdict on France’s solvency on Friday, November 29. A downgrade from "stable" to "negative" outlook now appears inevitable.

A Deficit and Public Spending Out of Control

With a budget deficit of 6.1% of GDP in 2024 and a target of 5% for 2025, France remains one of the most deficit-ridden countries in the Eurozone. The state is bloated, with public spending accounting for 57% of GDP, nearly half of which goes to social expenditures. This situation seemed sustainable when France could hide under Germany’s umbrella, but now that its neighbor is also facing difficulties, the government must summon its courage to make difficult but necessary choices.

While the spending cuts proposed by Michel Barnier point in the right direction, they may prove largely insufficient. For instance, pension expenses, the largest item in the state budget, benefit an age group that is already the wealthiest in the population—a unique case globally, except for Japan. It would have been wiser to consider capping the highest pensions while still increasing smaller ones, which would have saved expenditure on those who don’t need it while continuing to help the most vulnerable.

Growing Pressure on Interest Rates

The yield on French 10-year bonds is currently around 3.018%. This rate is forming a triangular pattern, with a key resistance level at 3.166%. If this threshold is definitively breached, particularly due to contagion from the U.S. bond market linked to Donald Trump’s policies, yields could climb to 3.604%. Such an increase would be detrimental to France’s public finances, making debt refinancing significantly more challenging.

On the other hand, if Michel Barnier manages to pass his reforms and hold his government together until 2025, rates could ease, falling below 2.768% with a target of 2.643%.

Investors on Edge

There is no doubt that investors' attention will remain focused on the French political scene throughout December. Every piece of news, whether positive or negative, could trigger strong market reactions. The country’s economic stability and financial credibility are at stake in the coming weeks.

Matéis Mouflet, Markets Analyst, XTB France