France’s election is a toss-up, but the economy is still facing rough ride

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Things aren’t looking good for France’s economy or its budget. And the forthcoming second round of the parliamentary election Sunday could make things even worse. 

“It’s almost like France has taken away the crown for financial instability from the United Kingdom,” said Susannah Streeter, head of money and markets at Hargreaves Lansdowne in Bristol, England. Britain went through similar tumult in September 2022.

So far this year, a sequence of events has turned investors cautious about investing in French bonds or stocks. On May 31, rating agency S&P Global downgraded the country’s debt, a significant move for the European Union’s second-largest economy. S&P’s report cited rising debt levels that could reach 112% of GDP by 2027, up from 109% last year. Last year’s deficit totaled a massive 5.5%. 

“The European Union has strict rules in terms of ensuring deficits don’t leap too high,” Streeter said. “It’s going in the wrong way for France.”

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But the worries go far beyond the EU’s rules. Investors are now dumping French government bonds, which has sent government borrowing costs higher, Streeter says. The yield on a 10-year French government bond recently hit 3.2%, up from 2.6% at the beginning of the year. That increase will burden the French government even more in interest payments on the debt.

Hot on the heels of the debt downgrade came the EU election, from June 6-9, which resulted in France’s far-right National Rally handily beating all other domestic political parties in the poll. Following that, centrist President Emmanuel Macron called a snap parliamentary election, the first round of which was held June 30. Again, the National Rally led the pack, but not enough to secure an overall majority in the parliament.

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As that was all happening, investors dumped French stocks, with the Paris CAC 40 index, roughly the equivalent of the U.S. S&P 500 index, plunging 6.7% in less than a month to 7,479 on June 28, down from 8,016 on June 6, according to data collated by TradingEconomics.com

Streeter says the French banks were the hardest hit because they hold large quantities of French bonds. And there is now a concern over unfunded spending pledges by both the far-right and the far-left parties, both of which have more electoral support than the centrist parties.

Worse still, the financial tension sent the value of the euro tumbling to $1.07 on June 28 from $1.09 June 6 on worries France might not be rescued from its financial problems, says Ivo Pezzuto, a Paris-based professor of global economics and competitiveness at the ISM Business School. 

“Now there might be a dysfunctional government, the concern is the potential vulnerability of France. In turn, that may spark financial volatility in the eurozone,” Pezzuto said. 

Put another way, a failure of France to get its fiscal house in order could result in economic turmoil.

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The French economy is looking weaker overall compared to the rest of the EU single currency area known as the eurozone. France grew 0.2% in the first quarter against an overall 0.3% for the entire eurozone. 

“It’s an unimpressive, sluggish recovery,” says Elias Haddad, a senior markets strategist at Brown Brothers Harriman in London.

The outlook isn’t much better when business leaders are asked. S&P Global estimates the French economy slowed to 0.1% growth in the second quarter. The report states that the private sector was deteriorating with a reading in its Purchasing Managers Index of 48.2 in June versus 48.9 in May. A figure below 50 shows economic contraction. 

“It doesn’t look so good,” Haddad said. 

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There is some good news. Cash-strapped workers got some relief so far this year following 2023’s cost-of-living crisis. Inflation peaked at 6.3% in February 2023, while wage increases peaked at a modest 4.7% in the first quarter last year, according to data from TradingEconomics.com. But there is some better news this year. Wage growth has been higher than inflation, according to the available data. 

“You do have positive wage growth now,” Haddad says.

“We expect full speed in 2025 because the inflation crisis is over,” said Leo Barincou, a Paris-based senior economist for Oxford Economics, noting the eurozone countries should improve in tandem.

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One advantage that will likely continue to help France is its relative lack of dependance on imported energy. 

“It was less hit by the energy crisis after Russia’s invasion of Ukraine in 2022, says Felix Huefner, a European economist at UBS. That’s quite a difference from Germany, the EU’s largest economy, which had relied heavily on natural gas imports from Russia.

France is also less dependent on manufacturing, and that’s good in France, which doesn’t rely heavily on manufactured goods as does Germany. “European people spend more on services than on manufactured goods,” Huefner says. 

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Despite the glowing potential economic outlook for France, there is a relatively high risk of violence breaking out when the results of the second round of Parliamentary voting takes place on July 7. After the first vote on June 30, violence broke out in protest of the National Rally leading in the polls. In anticipation of a possible repeat performance, the government has deployed 30,000 police nationwide, with 5,000 dedicated to Paris, according to press reports. 

Reporting by Simon Constable for FOX Business. 

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