French debt risk premium falls from 12-year high after vote, but investors cautious By Reuters

The French parliamentary election of 2022, held on a scheduled and a snap basis, has shown initial signs of a hung parliament, leading to a decrease in the risk premium that investors demand to hold French government bonds. This decrease in risk premium follows the first round of voting, which saw Marine Le Pen’s far-right National Rally (RN) party achieve historic gains, but the final outcome is still uncertain due to days of alliance-building before the run-off vote.

Analysts have suggested that a hung parliament may decrease the chances of big-spending policies from either the far left or the far right, which could potentially harm France’s fiscal position. Despite the feeling of relief on the financial markets, there is a general consensus that the situation is not yet fully resolved, as the National RN may still secure a relative or even an absolute majority in the final vote.

The decrease in risk premium has resulted in a narrowing of the gap between French and German 10-year sovereign bond yields, which serves as a gauge for the risk premium investors demand to hold French bonds. This gap, which had hit a 12-year high on Friday, has now tightened by 6 basis points (bps) to 74 bps. In contrast, the 10-year German Bund yield rose 12 bps to 2.61%, marking its highest level in two weeks.

The potential outcomes of the French election have also impacted the debt risk premium for other euro area countries. For instance, the spread between German and Italian 10-year yields narrowed 8 bps to 150 bps, while Greek, Spanish, Portuguese, and Belgian spreads also tightened.

However, France’s public finances are likely to face increased strain regardless of the election outcome. The European Commission has recently warned that France, along with Italy and five other countries, should be disciplined for running budget deficits over EU limits. Moreover, rating agency S&P Global has expressed concerns that policies advocated by the far-right National Rally could affect France’s credit rating.

Finally, investors are also monitoring German inflation data, which resumed its downward trend in June, potentially opening the door for another rate cut by the European Central Bank in September. The ECB has already cut rates by 25 bps in June, and markets currently expect it to cut rates at least once more this year, with around a 50% chance of a third rate cut. This situation could also impact the debt risk premium in Italy, the bloc’s most vulnerable country.

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