EU Faces Potential Fiscal Instability from France's Election Outcomes

France faces political climate shift ahead of National Assembly elections

by Faruk Imamovic
EU Faces Potential Fiscal Instability from France's Election Outcomes
© Getty Images/Antonio Masiello

Weeks before France's National Assembly elections will be held on June 30 and July 7, French politics are roiling over the country's economic future. A left-wing coalition, called the "Popular Front," and a populist-right faction, led by Marine Le Pen's National Rally (RN) are offering radical departures from the pro-market, fiscally responsible economic principles that have long underpinned French policy. If implemented, these changes could radically alter France's role as an EU partner and challenge world financial markets.

Diverging Economic Visions

In addition to a return to a 60-year-old retirement age and a higher minimum wage, the economic platform of the Popular Front calls for the return of many of the reforms of President Emmanuel Macron. They would pay for their proposals with higher taxes on profits and capital gains. The coalition will also say no to the EU's Stability and Growth Pact and will demand a European climate and social emergency package. They also call for setting prices for critical goods, such as food, energy, and fuel.

The rightist National Rally, by contrast, has not published an exhaustive fiscal blueprint but one of the few common themes is the early retirements - this time at 62, rather than 60. The RN prefers protectionism to protect French workers, and French companies from global competition. Programs of both factions are a radical departure from market-oriented policies and threaten lower fiscal discipline and EU relations.

Market Reactions and Economic Implications

The idea of a turn in French economic policy has already made itself felt on the financial markets. With traders always cautious about abrupt changes in politics the geopolitical landscape has seen the major currency pairs trade within tight ranges as consolidation applies in high frequency fashion. This can be observed on a macro level as the EUR/USD has been remarkably stable in comparison to more volatile economic conditions.

China's recent economic data release also plays into this narrative. Despite some areas of strength, China's overall growth remains uneven, contributing to global economic instability. Larry Hu, an economist, suggests that China's annual growth target of around 5% is still achievable, reducing the urgency for major stimulus programs. However, with the USD/CNY fix rising and approaching year-to-date highs, the People's Bank of China (PBoC) may allow further appreciation of the USD/CNY, contributing to the broader uncertainty in global markets.

EUR/USD© Getty Images/Matt Cardy

Ramifications to France and the End of the EU

These developments have significant economic implications in France. With a legislative majority in the national assembly for either the Popular Front or the RN, the power of the presidency over economic policy-making would be restrained by cohabitation, if President Macron were to continue in office with a prime minister from the opposite camp as happened under Presidents Mitterrand and Chirac. That departure could run afoul of EU fiscal rules and breach limits set by the European Commission, up to an "excessive deficit procedure" (EDP).

This would increase France's risk of default, possibly widening sovereign yield spreads and hence increasing borrowing costs. In France, the risk of a withdrawal from the eurozone is theoretically only after a serious imbalance of fiscal policy relative to the EU standards. The left and right alike might advocate opening up the Stability and Growth Pact to a new round of revision - or at least suggest that this should be the moment for France to pull rank.

Global Economic-Political Consequences

France's political developments could lead to significant economic repercussions. If the Popular Front or the RN gains a legislative majority, cohabitation between President Macron and a prime minister from the opposing camp would shift economic policy-making power away from the presidency. This shift could undermine France's adherence to EU fiscal rules, risking sanctions or even an "excessive deficit procedure" (EDP) from the European Commission.

Such a scenario would heighten the risk of France being unable to meet its debt obligations, potentially leading to wider sovereign yield spreads and increased borrowing costs. The possibility of France leaving the euro, although remote, could gain traction if fiscal policies deviate significantly from EU norms. Both left and right factions might argue for renegotiating the terms of the Stability and Growth Pact, leveraging France's significant role in the EU.

All Eyes on the Fed

And in the US, it only really matters what the Federal Reserve does with monetary policy. Recent statements by Fed Chair Jay Powell have signaled a more hawkish stance, suggesting possible interest rate hikes to combat inflation. Market participants are keenly observing comments from New York Fed President John Williams and Philadelphia Fed President Patrick Harker to gauge whether they will support Powell's position. The USD Overnight Index Swap (OIS) forward curve currently projects two rate cuts in 2024, contrasting with the Fed's indications of a single cut, highlighting the uncertainty surrounding U.S. monetary policy.