Jul 10 / Alef Dias

Elections in France reduce short-term risks, but long-term remains challenging

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Elections in France reduce short-term risks, but long-term remains challenging

  • The left-wing NFP alliance won the largest number of seats in France's legislative elections, with Emmanuel Macron's Ensemble in second place and the right-wing RN well below expectations in third.
  • This result eliminated the most serious short-term economic and fiscal risks posed by an absolute majority for the RN or the NFP, but the long-term consequences of the vote could still be significant. The debt was already on an unsustainable path and the economic growth trend is sluggish.
  • With the reduction in short-term risks, the euro could continue to be heavily influenced by expectations of the Fed starting to cut interest rates. In the long term, the French election is likely to put further pressure on the euro, as yet another economy in the bloc remains far from resolving its fiscal imbalances.

Introduction

After strong results for Marine Le Pen's right-wing Rassemblement National (RN) party in the first round of the French legislative election, the results of the second round brought a very different scenario. The left-wing NFP alliance won the most seats in the election, with Emmanuel Macron's Ensemble in second place and the RN in third. With no group able to command a majority, this probably means that the left and center parties will need to form a coalition government or jointly support a more technocratic administration. 

Given this situation, we will analyze the possible scenarios for the future of French economic policy and how they could affect the euro.

Image 1: New Composition of the French Parliament

Source: G1

Image 2:  Debt/GDP estimates - France

Source: Bloomberg

Tail risks have been diminished, but the fiscal scenario remains worrying

Any opinion on the new government's policies is necessarily speculative at this point. What is clear is that, with an expected deficit close to 5% of GDP in 2024 and a debt of around 111% of GDP, France is starting from a tense fiscal position.

With no group capable of commanding a majority, France now faces a period of political uncertainty. Whatever configuration is agreed, it is likely to be supported by the left, which advocates an increase in spending. Even so, neither the far right nor the left-wing alliance won an absolute majority, taking extreme fiscal stimulus off the table.

As an illustrative scenario, let's consider if the new government accepts President Macron's stability program, with a deterioration in the deficit of 0.5% of GDP, keeping the spread against German bond yields at around 75 basis points.

Image 3: Quarterly GDP growth France (%)

Source: Refinitiv

Image 4:  10-year Yields (%)

Source: Refinitiv

Short-term trends could continue

The French economy has proved resistant to rising interest rates, expanding in almost every quarter since the European Central Bank (ECB) began tightening monetary policy in mid-2022.Even so, growth has been slow and is not yet showing many signs of recovery. Growth fell slightly to 0.2% in 1Q24, from 0.3% in 4Q23, and weak business sentiment suggests it will remain subdued in 2Q. Bloomberg estimates point to GDP growth of 0.2% again, while the Banque de France's latest forecast is more pessimistic, at 0% to 0.1%.

On the price side, French inflation fell in June to 2.5% from 2.6% in May, mainly due to energy and food. Eurostat data showed that increases in energy prices fell to 4.5% from 5.5% in May, probably due to a reduction in fuel prices. Food inflation also fell, mainly due to base effects. Meanwhile, core goods inflation remained stable and price gains in services increased, bringing core HICP inflation to 2.4% from 2.3% in May.

With inflation slowing and the ECB having started to cut rates, the increase in consumer spending and the recovery in investments could support a gradual strengthening of growth prospects. However, the elections and political uncertainty could weigh on confidence and add some downside risks.

Image 5: Price Indexes France (YoY, %)

Sources: Refinitiv

In Summary

The left-wing NFP alliance won the largest number of seats in France's legislative elections, with Emmanuel Macron's Ensemble in second place and the right-wing RN well below expectations in third.

This result eliminated the most serious short-term economic and fiscal risks posed by an absolute majority for the RN or the NFP, but the long-term consequences of the vote could still be significant. The debt was already on an unsustainable path and the economic growth trend is sluggish. With the chances of fiscal deterioration and political paralysis increasing, the likelihood of these problems being resolved has decreased.

With the reduction in short-term risks, the euro could continue to be heavily influenced by expectations of the Fed starting to cut interest rates - if the data continues to show economic activity close to stagnation in the euro zone and inflation continues to converge towards the ECB's 2% target. In the long term, the French election is likely to put further pressure on the euro, given that yet another economy in the bloc is still a long way from resolving its fiscal imbalances.

Image 6: Price Indexes France (YoY, %)

Sources: Refinitiv

Weekly Report — Macro

Written by Alef Dias
alef.dias@hedgepointglobal.com
Reviewed by Victor Arduin
victor.arduin@hedgepointglobal.com
www.hedgepointglobal.com

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