Mind the Crowds!

The outcome of the French elections remains highly uncertain. Voting intentions are gravitating towards the three main blocks as those attached to smaller political families probably want to make their vote count, and RN retains its dominant position. More polls providing seat projections put RN closer to the majority threshold, but judging by the surveys a hung parliament remains (just) the most plausible outcome. A lot will depend on how many qualifying candidates from the historical government parties in third position in the first round will decide to withdraw from the second round to contain the far right.

The announcement by the European Commission that France, along with 7 other member states, is back under “Excessive Deficit Procedure” (EDP) – although it did not have much of an impact on spreads so far - is another occasion to realise that corrective action is needed to avoid a major drift in public debt. This is a blind spot in France’s current debate, organised around “moderately spendthrift” and “very spendthrift” proposals from the two political forces leading in the polls. Incidentally, the fact that Italy is again under EDP as well should be a reminder that the “Meloni blueprint”, often used to sketch out what could be the economic approach of a RN-led government in France, has not yet been tested for a potentially painful fiscal tightening under close EU monitoring.

French banks’ equity prices have improved slightly from their low on 14 June. Fortunately, their exposure to the sovereign is small relative to their Italian counterparts for instance. Yet, before the Great Financial Crisis of 2008, French and Italian banks had very similar levels of exposure. The experience acquired during the “bad old days” of the early 2010s suggests that going the “Italian way” and getting local banks to take up a rising share of local public debt, while understandable from a financial stability point of view, can become economically toxic as this crowds out lending to the private sector and depresses growth on trend. There is domestic space to absorb French debt, but using up this space would still entail a macroeconomic cost.