French elections heighten economic uncertainty, investors uneasy

The upcoming Sunday elections in France are in a rather tense political situation. It's a question of whether Emmanuel Macron will continue to govern the country or if more Eurosceptic parties will take over. The latest signals from the economy confirm that it is in a phase of clear slowdown. Could this affect the election results?

The French economy has had another tough month. The level of the main PMI indicator fell to 48.2 in June from 48.9 points noted in May. This means the French economy is again moving away from the 50-point line that marks the boundary between recession and recovery. The renewed drop in new orders recorded in June puts the results of the eurozone's second-largest economy at the end of the first half of the year in question. Similarly to Germany, Paris is struggling with a decline in economic activity in industry and services after the April revival, according to the latest S&P data.

Norman Liebke, an economist at Hamburg Commercial Bank, forecasts that the French economy likely grew by only 0.1 percent in the second quarter of 2024.

He also explains that the planned Sunday parliamentary elections may have been a factor contributing to the slowdown in business activity.

Uncertainty related to the upcoming elections means that French companies are holding back on investments and preparing for worse times. According to some respondents, the lower level of activity was directly related to the upcoming elections, Liebke explains, as quoted in the S&P report.

It's not only French entrepreneurs who are waiting. As Bloomberg notes in its commentary, the early elections to the National Assembly in France are being closely watched by investors. This is evidenced by the spread between German and French 10-year bonds, which has reached its highest level since 2012. One of the post-election scenarios is a sharp increase in France's debt.

The election outcome does not have to be clear-cut. Experts consider a political deadlock the most likely scenario. The National Rally will most likely win the most seats in the National Assembly but will not achieve a majority.

The second scenario is a situation where the far right wins enough votes to form a government, forcing President Macron into cohabitation. The reaction of the bond market will depend on the rhetoric adopted by the new government.

The third possibility, considered by experts to be the worst from an investor's point of view, is an unexpected victory of the New People's Front. Such an outcome would most likely mean a significant increase in the yields on French treasury bonds.

The last, although currently the least likely scenario, is Macron's party and its allies maintaining their position as the largest group in the parliament. For the bond market, this would probably be the best election result.

France, as one of the most developed countries in the world, is characterized by a high level of budgetary spending, particularly in the area of social benefits. According to OECD data, in 2021, France's public expenditure accounted for 59.2 percent of its GDP, placing it fourth among member countries of the organization.

A significant portion of these expenditures consists of social transfers, which in 2020 amounted to 23.4 percent of GDP, one of the highest figures among OECD countries. France also allocates substantial resources to education - in 2020, public spending on this purpose accounted for 5.4 percent of GDP, exceeding the OECD average of 4.9 percent.

In terms of defense spending, in 2021, France allocated 1.9 percent of its GDP, which, in absolute terms, made it the third largest NATO country in terms of defense budget.

France is characterized by an average annual GDP growth of 1.1 percent. At the same time, France has had a deficit of 5 percent of GDP since 2019. Therefore, in the spring of this year, the government announced major cuts totaling $11 billion.

Bruno Le Maire, French Minister of Economy and Finance, who criticizes Macron's decision on early elections, fears its consequences. In an interview with "Le Monde," he expressed concern that a victory for the extremes would lead to a financial crisis.

"The French economy is solid. We have put it back on the right track. On the other hand, we have a financial situation that should prompt us to save, invest, which would give us some room for maneuver in the event of another crisis," he said.

The programs of both the far left and the far right are unbearably carefree. Our creditors and markets have understood this. For the past two years, the difference in yields between French and German ten-year bonds, a measure of investor confidence in France, had stabilized at 0.5 percent, thanks to a strategy aimed at restoring the credibility of public accounts. Since the opposition presented its programs, this difference has risen to 0.8 percent, to a level not seen in seven years. Since then, France borrows more expensively than Portugal. And we risk quickly paying more than Spain. This increase of 0.3 percent means $1 billion in additional annual expenditures for the state and $5 billion over five years," he argued.

Comparing the growth dynamics of real Gross Domestic Product (GDP) of the five largest economies in Europe from 2011 to 2021 shows diverse development paths for these countries. Eurostat data shows that the highest average annual GDP growth rate in Europe during the researched period was recorded by the United Kingdom (1.9 percent), ahead of the other leading European economies. Germany, the largest economy in Europe, achieved an average annual growth of 1.5 percent.

According to current polls, the far-right National Rally of Marine Le Pen has the highest support of 34.2 percent. The leftist coalition New People's Front is in second place with 28.2 percent, and President Macron's camp is in third place.