The sudden announcement by President Emmanuel Macron of the dissolution of the National Assembly was a financial opportunity for Matthew Russell. The fixed-income manager at asset management group M&G says he bought French government bonds in the days following the announcement. The London-based trader, who is barely familiar with the details of French politics, did some simple math: French interest rates had risen by about 0.3 percentage points to 3.3% by then, and while yields were improving, the risks still seemed very low. “The European Union won’t let France default,” he believes, and he’s betting on the fact that the European Central Bank (ECB) is always ready to step in if panic breaks out.
This anecdote reminds us of a fundamental truth: there are (almost) always buyers on financial markets. But there are not buyers at every price. Taking this into account, a far-right National Coalition government and uncertain majority prospects will not push France into default and bankruptcy. On the contrary, they are likely to cause great damage to the country. Since the breakup, the difference in interest rates between France and Germany (the “spread”) has already risen from 0.5% to 0.75%, reaching 0.8% on Monday, July 1, when the results of the first round of parliamentary elections were announced.
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“The danger is a prolonged fiscal collapse,” explained Gilles Moeck, chief economist at AXA Group. In this light, it is worth recalling two recent shocks in Europe: the financial panic unleashed by Liz Truss in the UK in October 2022 and Italy’s long recession in 2018-2019, when the Five Star Movement was in power.
Liz Truss’ UK fiasco
On 23 September 2022, the government of then-new Prime Minister Truss introduced the biggest tax cuts since 1972. How was this gift going to be financed? The government claimed it would raise growth to 2.5% per year. Nobody bought it in the financial markets. Within a week, interest rates on UK government bonds jumped from 3.1% to 4.5%. It took the intervention of the Bank of England, the reversal of most of the measures, and Truss’s humiliating resignation after 44 days in office to put an end to the chaos.
“But the tax cuts weren’t that big. [it was €50 billion, to which had to be added help with energy bills, amounting to €85 billion in additional borrowing, the equivalent of 2.3% of GDP]” recalls David Owen, a British economist and founder of the consulting firm Saltmarsh Economics. He thinks Truss’s real failing was the brutal way in which she presented the budget.
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