Italy used to be the bad boy of Europe. Now, France is taking the baton

France is facing severe political instability as Prime Minister Bayrou's government anticipates a likely no-confidence vote next week over a contentious 2026 budget, threatening further political deadlock and a fifth prime minister in less than two years. This turmoil has led economists to unfavorably compare France's fiscal outlook, citing its 5.8% deficit (compared to Italy's 3.4%), despite a lower debt-to-GDP ratio. The escalating political risk and challenges in fiscal consolidation, including a proposed €44 billion in cuts to bring the deficit to 4.6% (still above EU rules), have prompted significant market concern. This is evidenced by France's 30-year bond yield rising above 4.5%, a level last seen in 2008, signaling material concerns about debt sustainability and compliance with EU fiscal rules.

Analysis

France is facing a severe political and fiscal crisis, with Prime Minister Bayrou's minority government facing a likely defeat in a confidence vote over a contentious 2026 budget. This political instability has led to unfavorable comparisons with Italy, as France's budget deficit stood at 5.8% of GDP in 2024, significantly higher than Italy's 3.4%. While the proposed budget aims to implement €44 billion in cuts to reduce the deficit to 4.6%, this target remains well above the EU's 3% limit and faces strong opposition. Analyst consensus, including from Nomura and Eurasia Group, points to a government collapse as the base-case scenario, which would likely freeze the 2025 budget and lead to an even higher deficit in 2026. This has raised material concerns about France's debt sustainability, directly impacting markets as evidenced by the 30-year French bond yield rising above 4.5% to a level last seen in 2008, signaling significant investor anxiety.

Key Decisions for Investors

• Investors should consider reducing exposure to French sovereign bonds (OATs) given the rising fiscal risks and political instability, which are likely to exert continued upward pressure on yields.
• Caution is warranted for investments in French domestic-focused equities, as a potential government collapse and prolonged budget uncertainty pose significant headwinds to economic stability and corporate confidence.
• Monitor the yield spread between French OATs and Italian BTPs, as the unfavorable comparison of France's fiscal trajectory to Italy's could lead to further convergence of this key sovereign risk metric.
• The upcoming confidence vote is a critical near-term catalyst; a government collapse, the widely expected outcome, would likely trigger heightened volatility and negative sentiment across French assets.