French President Emmanuel Macron attends a ceremony at the Mont-Valerien memorial in Suresnes, outside Paris, on June 18.LUDOVIC MARIN/Getty Images
It is never a good sign when central bankers have to publicly reassure markets that they are monitoring the situation closely. But that is what European Central Bank officials did on Monday amid concerns that France is headed toward its very own Liz Truss moment.
Ms. Truss’s record-short stint as Britain’s prime minister in 2022 was marked by an unprecedented Bank of England intervention in financial markets, after her government tabled a reckless mini-budget that included tens of billions of pounds in unfunded tax cuts. The central bank was forced to pledge unlimited buying of British bonds to stem a market sell-off that had sent the pound to its lowest-ever level against the U.S. dollar.
Flash forward to last week and French President Emmanuel Macron’s rash decision to call snap legislative elections. The Paris stock market tanked, and the spread between French and German bond yields soared, as investors feared Mr. Macron’s political gamble could lead to financial chaos if either the far-right National Rally or leftist New Popular Front wins the largest number of the National Assembly’s 577 seats on July 7.
The timing of the vote could not be worse. France is just coming off a debt downgrade last month by S&P Global Ratings, as it grapples with an intractable budget deficit that hit 5.5 per cent of gross domestic product in 2023. The election of a far-right or far-left government, or a hung parliament in which no party or coalition holds a majority, now threatens to deepen the country’s fiscal mess.
Explainer: How do France’s parliamentary elections work?
Paris Bourse’s main CAC 40 stock index fell more than 6 per cent last week, while the stock prices of France’s leading banks were down by double digits. French banks are among the largest holders of French Treasury bonds, known as obligations assimilables du Trésor, or OATs, whose spreads against German bonds widened to their highest levels since 2017.
BNP Paribas, Société Générale and Crédit Agricole are considered global systemically important banks, or GSIBs, by the international Financial Stability Board, which raises the risk of widespread market contagion should they face liquidity problems. The French banks are already facing higher financing costs amid fears about the outcome of the French legislative vote.
Mr. Macron, whose second and final presidential term ends in 2027, called the snap domestic vote after the National Rally surged into first place in European Union elections held on June 9. But if Mr. Macron had hoped anti-National Rally voters across the spectrum would rally behind him to block the far-right party from emerging victorious in the legislative vote, he has so far been sadly mistaken.
Polls show the National Rally now with the support of about one-third of French voters in advance of the June 30 first-round ballot, compared with about 28 per cent for the New Popular Front, a coalition of four progressive parties led by the far-left France Insoumise (or France Unbowed). Mr. Macron’s coalition of centrist parties is polling at under 20 per cent. The top two finishers on June 30 will move on to the July 7 second ballot.
“What was going through Macron’s head when he called this election will never be clear, and the pace at which events have moved against him since June 9 is remarkable,” TD Securities said in a Monday note.
“The handover in support in the polls from the protest-vote EU elections to the domestic French legislative elections by the [National Rally] throws heightened uncertainty over the eventual outcome.”
On Monday, European Central Bank chief economist Philip Lane sought to reassure investors, saying that “what we’re seeing in the markets is repricing. But it’s not in the world of disorderly market dynamics that would pose a series of traps to the transmission of monetary policy.”
ECB president Christine Lagarde also commented, saying that “my obsessional objective is to return inflation to the target of 2 per cent in the medium term. Price stability extends in parallel to financial stability, So, we pay attention to the proper functioning of financial markets.”
Still, that financial analysts are openly speculating about potential ECB intervention in bond markets similar to the Bank of England’s 2022 moves is deepening investor skittishness in the run-up to what is shaping up as a make-or-break election.
While the National Rally is now hedging on its promise to repeal Mr. Macron’s 2023 pension reforms, which raised the retirement age to 64 from 62, it has not backed down on its other signature spending promises, including its vow to slash the value-added tax on fossil fuels and electricity to 5.5 per cent from 20 per cent.
The New Popular Front promises to repeal the pension reform within 15 days of taking power and reduce the retirement age to 60 after that. It would also raise the minimum wage and reinstate a wealth tax on financial assets that Mr. Macron killed.
The European Commission is expected to sanction France on Wednesday for being in breach of EU budget rules that limit deficits to 3 per cent of GDP. The move would make France subject to an “excessive deficit procedure,” requiring it to submit a deficit-reduction plan.
Both the National Rally and the New Popular Front say they would refuse to submit to EU budgetary diktats. France’s Liz Truss moment could make Britain’s look tame.