France’s borrowing costs converge with Spain’s as fiscal concerns grow

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France’s borrowing costs have converged with Spain’s as investors worry about Paris’ ability to close its budget deficit.

France’s 10-year bond yields rose to their highest level compared with Spain’s since the 2008 financial crisis to 2.95% and 2.96%, respectively, amid investor concerns about rising risk politically and economically in France, even if its southern neighbor focuses more on fiscal consolidation.

Meanwhile, the spread between French and German 10-year borrowing costs – seen as a barometer of the risk of holding France’s debt – hit its highest level in seven weeks. It rose to 0.79 percentage points on Monday, up from 0.71 percentage points in early September.

The rising premium for holding French debt came as Prime Minister Michel Barnier’s new government asked the European Commission on Monday for a further delay in presenting its plans to comply with EU tax rules.

“French markets are under pressure as it becomes clear that the Barnier government faces a difficult future at best and the risk of collapse at worst,” said Mark Dowding, chief investment officer at RBC BlueBay.

Investors are increasingly skeptical that France will implement the budget cuts demanded by the EU, especially as the rise of populist parties in France and Germany potentially weakens the bloc’s political power to make countries comply with its debt rules.

The European Commission wants to reduce public deficits below 3% and public debt below 60% of GDP. France’s debt was 111% of GDP at the end of March this year, while the budget deficit is expected to rise to at least 5.6% in 2024.

“It will be difficult for Europe to enforce this. . . where does that leave us? It leaves investors forced to impose some austerity on French markets. That’s the concern,” said Kevin Thozet, a member of the investment committee at French fund manager Carmignac.

Investors are also concerned that Barnier may not be able to prevent a no-confidence vote in parliament in the coming months.

The gap between French and German borrowing costs has almost doubled since early June, before President Emmanuel Macron called for early parliamentary elections, triggering months of political instability as the country grapples with deteriorating public finances.

The European Commission has placed France in what it calls the excessive deficit procedure, which puts additional scrutiny on the spending plans of Barnier and his new government.

Over the weekend, Barnier appointed two ministers reporting directly to him to help draft the 2025 budget and outline cuts to reduce the spiraling public deficit.

“The debt, the economy and the political situation in France all warrant a significant trade-off for holding French government bonds,” said James Athey, fund manager at investment firm Marlborough.

The latest volatility in French markets adds to the blurring of traditional lines between the bloc’s riskier and safer bond markets.

The Spanish government’s benchmark borrowing cost spread over France’s has fallen from almost half a percentage point six months ago to 0.01 percentage point.

“Periphery countries like Spain continue to perform much better than France,” said Tomasz Wieladek, chief European economist at T Rowe Price. “For now the Spanish political situation is much more stable. . . the economy is also clearly growing.”

Portugal, which was bailed out during the eurozone crisis, had benchmark bond yields lower than France’s in June.

Meanwhile, Italy’s debt risk premium over France’s has fallen from 1.3 percentage points to almost 0.6 percentage points over the past year.

“If France cannot address the structural problems, it will join Italy on the periphery of the eurozone, with the country’s semi-core credit status now in doubt,” Dowding said.

Additional reporting by Rafe Uddin