The ongoing political instability in France is poised to inflict economic damage, according to Andrew Kenningham, Chief European Economist at Capital Economics. Kenningham suggests the nation is heading towards a fiscal crisis, increasing the risk premium on French debt over the next one to two years. He notes that while the immediate impact on the private sector may be limited and contagion risks contained, prolonged political deadlock will amplify the risks.
Kenningham predicts that regardless of the political outcome, France’s budget deficit is likely to remain above 5 per cent of GDP, leading to a continued rise in the national debt. This situation is expected to drive a significant increase in French government bond yields, with the 10-year spread to Bunds potentially exceeding 100 basis points in the coming year. The analyst wrote in a note that the longer the impasse lasts, the greater the risks.
Despite the grim outlook for France, Capital Economics anticipates limited contagion to other Eurozone countries. Kenningham points out the absence of regional imbalances that could endanger a group of nations, unlike during the Eurozone crisis. Furthermore, the European Central Bank’s (ECB) willingness to intervene to prevent unwarranted spread widening should deter bond vigilantes and maintain stability across the Eurozone.
Kenningham concludes that provided a future government eventually tightens fiscal policy, the fallout for the private sector should not be huge, and contagion risks should be modest. The ECB will likely step in if needed, providing some reassurance to markets despite the ongoing political turmoil in France.
