Three tussles facing the incipient French government

Fragmentation, stalemate and potential tests of strength with markets and ECB

An incipient French government set to emerge in coming weeks amid political fragmentation and decision-making paralysis will face a trio of tussles – with a potentially grave impact on European unity. No serious instability is expected in the next few weeks as the Paris Olympic Games and the holiday season get underway. But this could be a summer calm before autumn squalls – and a still more unsettled 2025.

That is the broad conclusion of a series of OMFIF conversations and roundtable meetings, following the two rounds of the French legislative elections that ended in a parliamentary stalemate on 7 July.

National Assembly fragmentation

The first struggle will be within the French political system. The three broad factions – the left, centre and far right – which will account for most seats in the next National Assembly, must choose among their own groupings and with each other, possible candidates for the post of prime minister.

A designated PM will have to make deals and alliances beyond individual party boundaries and with President Emmanuel Macron, the lonely, embattled and possibly terminally inoperative Élysée Palace incumbent. For now, Macron has refused to accept the resignation of Gabriel Attal, the current prime minister, and asked him to stay on as caretaker. The interregnum could last for much of the summer, depending on the fractiousness of the National Assembly and the country at large.

Second, a new administration will face a test of strength with financial markets watching out for signs of fiscal indiscipline and further deterioration of ability to meet standards set by the European Commission. The Commission’s decision in June 2024 to open an ‘excessive deficit procedure’ against France amounts to a shot across the bows.

The Commission’s state of flux after the June European parliament elections, and the still imperfect understanding of the new debt sustainability rules brought in at the end of 2023, allow a new team in Paris a small amount of leeway. One view expressed at an OMFIF roundtable on the snap election in France was that the markets are likely to be less forgiving than Brussels.

Another financial specialist pointed out how France’s debt and deficit ratios have deteriorated much faster than for other peer countries within the euro area. A third participant commented that additional spending and reductions in income advanced by parts of the left-wing New Popular Front – which unexpectedly came out ahead in the 7 July poll – could burden the public finances by up to €100bn a year.

Resilience test for ECB council

The third battle could be with the European Central Bank. When the ‘transmission protection instrument’ was decided in July 2022, it was widely thought that the first country to take advantage of the scheme to control government bond ‘spreads’ could be Italy.

French political meteorology has now led to a shift in opinion. If the ECB governing council accepts that sharp rises in French bond spreads against Germany are ‘unwarranted’, then France could face the indignity of being the first country to make use of the scheme. At present, the gap between 10-year French and German government bonds is relatively small at 0.60 percentage points. However, if this was to widen markedly and sustainably, and the ECB was poised to purchase French bonds to lower the margin, then this would be a great test for the resilience of the ECB council as well as for the new government.

General opinion from seasoned participants at OMFIF briefings has been that a new administration would be likely to bow to real and potential financial market pressure and rein in deficit plans before any test of strength with the ECB. However, the prospect of a political stand-off with the independent ECB over debts and deficits would be the worst possible outcome both for a new administration in Paris and the central bank itself.  Meanwhile, uncertainty in Paris is one more reason why the ECB is highly unlikely to cut interest rates at its next policy meeting on 18 July.

Macron, with the power to appoint the prime minister and with supremacy in the key fields of defence, security and foreign policy, is a diminished but still pivotal figure. His gamble to call early legislative elections, for which he was widely criticised in France and abroad, has resulted in avoidance of a far-right government. In the words of one OMFIF participant, that is ‘the least worst outcome’. Another stated that France lived up to the normal pattern in the two-round election process of using the first stage to register a protest and the second to decide the government.

Macron’s decision

But avoiding the worst outcome is hardly the landmark political ‘clarification’ that Marcon sought. He may stumble on with a difficult-to-assemble majority government in an improbable cross-party parliamentary alliance. Another possible outcome is an unstable minority government. A third less likely consequence could be a technocratic administration run by a figure respected across the political spectrum – with ministers from left and right, and others from civil service or industrial backgrounds. All of these outcomes, ahead of possible further elections next year, will be tenuous and fragile.

Meanwhile, the run-up to Germany elections in autumn 2025 will put further strain on the already severely weakened Franco-German alliance. At an official conference commemorating the 25th anniversary of the euro at the German finance ministry in Berlin on 7 June, no leading French participants were invited.

Much of the meeting was devoted to criticism of French economic and budgetary policies by a range of speakers, with the noticeable exception of a more emollient Joachim Nagel, Deutsche Bundesbank president. Within the ECB council, Nagel could play a key role if tensions rise on the markets in the autumn and beyond.

David Marsh is Chairman of OMFIF and Taylor Pearce is Lead Economist, Economic and Monetary Policy Institute at OMFIF.

Image credit: Jeanne Menjoulet

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