France gets only brief reprieve from budget pressure

By Leigh Thomas, Jan Strupczewski and Yoruk Bahceli

PARIS (Reuters) -Financial markets cheered last week's defeat of no-confidence votes in the French government but any reprieve in weeks of political chaos will be short-lived unless budget talks starting on Monday find the savings needed to cut the country's deficit.

A deal to suspend implementation of President Emmanuel Macron's controversial hike to the state retirement age allowed his government to live another day. But it made the task of putting the country's finances on a stable footing more difficult.

"We still think French debt, the political situation and the reluctance of the French people to be ready to make sacrifices and implement fiscal consolidation mean you need to pay more to issue your debt," said Apolline Menut, economist at Carmignac.

S&P GLOBAL CUTS CREDIT RATING

Driving home the point, S&P Global cut France's credit rating on Friday in a surprise update on the euro zone's second-biggest economy, citing concerns that political instability would keep France from getting its finances under control.

After three downgrades from Fitch, DBRS and S&P in a little more than a month, Moody's is next in line to update on France at the end of the week.

Analysts say French borrowing costs at around 3.36% on its 10-year paper - roughly the same level as highly indebted Italy - have long reflected lower ratings.

"With the current downgrade, France falls below AA- from 2 of the three rating agencies, and it should result in forced selling from a number of institutional investors who are sensitive to ratings," said Mohit Kumar, chief economist/strategist Europe for Jefferies.

Prime Minister Sebastien Lecornu aims to reduce the budget deficit to 4.7% of GDP next year from 5.4% in 2025, as a first step toward bringing it below the EU’s 3% ceiling - widely seen as the threshold for putting debt on a sustainable path.

PLAN TO OFFSET DELAYED PENSION CHANGE

Speaking at the IMF annual meeting in Washington, European Economic Commissioner Valdis Dombrovskis told Reuters that suspending the pension reform carried a "sizeable cost" but noted that the government intended to offset the impact.

Lecornu aims to tighten public finances by over 30 billion euros through tax hikes and spending cuts — France's biggest budget squeeze in more than a decade.

While many lawmakers in the fractured parliament are already gearing up to dilute his savings plan, Lecornu insists the deficit must stay below 5%.

"If lawmakers resort to obstruction with a flood of amendments, it's going to be a rough ride - real parliamentary guerrilla warfare," said centrist MoDem MP Erwan Balant, whose party backs Lecornu.

LITTLE SIGN OF CONTAGION FROM FRANCE FOR NOW

So far there is little evidence of contagion to the rest of the euro zone.

Although the risk premium on French bonds eased after the pension reform delay, it still remains well above levels seen before the summer of 2024 when Macron plunged France into uncertainty with a snap election.

Public audit office head Pierre Moscovici told a Senate hearing on the 2026 budget that France could even see its debt levels overtake those of Italy by 2029, adding: "We are alone in the situation we've put ourselves in."

Investors are for now reaching the same conclusion, judging that France's political and market pain is even having a salutary effect in encouraging others such as Italy to pursue their deficit-cutting paths.

"Politicians will say: 'If that's the road France wants to take, the bond market is the price they will have to pay. I don't want to take that path, because I don't want to pay that price in the bond market'," said Rohan Khanna, head of euro rates strategy at Barclays.

France's EU partners are meanwhile eager to see Paris get out of its rut to help push forward long-stalled pan-European projects like capital markets union.

"It is true that we are watching very closely what is happening politically in France, and I want a stable government with which I can advance important projects," German Finance Minister Lars Klingbeil said on a panel in Washington.

(Reporting by Leigh Thomas in Paris, Jan Strupczewski in Washington and Yoruk Bahceli in LondonAdditional reporting by Elizabeth Pineau in ParisEditing by Frances Kerry)