In the West, a rising right-wing tide risks raising inflation and debt

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John Rapley is an author and academic who divides his time among London, Johannesburg and Ottawa. His books include Why Empires Fall (Yale University Press, 2023) and Twilight of the Money Gods (Simon and Schuster, 2017).

As uncertain as the outcome of Sunday’s French legislative election remains, there’s probably one safe bet: the Macron era is over. The share of the seats French President Emmanuel Macron’s party holds in the National Assembly will likely plunge, and a new government that is either weak or hostile to his agenda will emerge, making him a lame-duck president.

Meanwhile the far right, which is emerging as the front-runner in French politics, has lavish spending plans. It is opaque about how it will cover the ensuing costs. But whoever becomes prime minister and leads the new government, the calls to increase spending will likely strengthen. That, along with sticky labour costs, will put further upward pressure on inflation and borrowing costs.

Beyond its obvious importance for France, that development may have profound implications for all of us.

That’s because this drama raises the stakes of similar events abroad. A rising far right across Europe, which is elevating nationalist and anti-immigration politicians in several countries, is both complicating Europe’s attempts at reform and compounding labour shortages. The effect will be to constrain already-tight labour markets and thereby raise wages, especially at the lower end where immigrants plug so many gaps.

Further complicating matters is that these developments land square in the middle of a volatile political season in the United States. The first round of the French election occurred within days of the first presidential debate in the U.S. After President Joe Biden’s disastrous performance, the odds of a Donald Trump victory in November’s election shot up. Given that Mr. Trump not only wants to take an even harder line than Mr. Biden on immigration but also plans to sharply raise tariffs and make his tax cuts permanent, both the U.S.’s persistent inflation and increasing fiscal deficit look set to worsen.

Taken all together, the trends in both debt and inflation are thus rising on both sides of the Atlantic. Anticipating this, global bond traders have been demanding higher yields on the money they loan to governments. This effect is not confined only to the countries with fiscal accounts deep in the red. It’s happening across the board, because bond investors looking for higher returns are getting better offers elsewhere. And so, for example, the interest rates on the 10-year government bonds of G7 countries are up half a percentage point or more since the start of the year. Here in Canada, it’s actually risen further since the Bank of Canada recently cut short-term rates.

Sunday’s election in France will thus occur just as markets across the developed world are already on tenterhooks. It’s difficult to predict the outcome.

At present, we’re unlikely to see the sort of crisis Britain experienced after the disastrous budget introduced by Liz Truss’s short-lived government that shook markets around the world, though of course things could change. More likely will be a hung parliament divided between the far right and the far left, which has been polling in second place, with a squeezed and weakened Macron movement in the middle, unable to do much. Even if Mr. Macron’s current Prime Minister, Gabriel Attal, is able to retain his office, the government would probably be crippled by inertia, forcing the President to abandon his reform agenda. And given the reforms that Mr. Macron was driving both in France and in Europe, that will probably prolong the economic funk in which Europe now finds itself, with inflation proving stubborn and bond yields continuing to drift upward.

This scenario will complicate the work of all central banks that are currently trying to engineer soft landings in their economies, bringing down interest rates while keeping inflation from rebounding. The Bank of Canada faces an especially tricky task. Domestic conditions currently justify its easing stance, but the international context makes it harder to pull off. Meanwhile, given the country’s dependence on trade, it remains especially sensitive to movements in currency and bond markets elsewhere.

Assuming bond yields keep rising among our major trading partners, so will those here. Canadians looking for substantial mortgage relief may have to wait longer than they were expecting.