French political risk and the euro By Investing.com

Investing.com — The French government bond market experienced significant stress following the weekend European elections, with the 10-year OAT-Bund spread widening sharply by 7-8 basis points, reaching the widest levels seen since last year. The strain on the bond market isn’t surprising after Standard & Poor’s recently downgraded France’s sovereign credit rating to AA- from AA amid budgetary concerns. The downgrade was influenced by last year’s larger-than-expected budget deficit of 5.5% of GDP, which was attributed to weak growth and soft revenues.

Macron’s government was already struggling with fiscal consolidation, and the concern is now that any National Rally (RN) government will follow a Trump-esque approach to fiscal consolidation – aiming to stimulate growth as a means to address fiscal issues.

On June 19, economists from ING anticipate that the European Commission may initiate its Excessive Deficit Procedure against France, which could have significant repercussions for the euro. The response of France’s next government to this procedure will be crucial. With the latest opinion polls suggesting that Marine Le Pen’s RN party may win the largest vote share in the upcoming elections on June 30 and July 7, but fall short of an absolute majority, the focus is likely to shift to the potential coalitions and their policy implications.

In the current climate, the euro is expected to face difficulties in rallying, with predictions suggesting it will hover around the 1.07/08 mark, subject to downside risks. Today, attention turns to eurozone speakers, including European Central Bank Chief Economist Philip Lane, who is scheduled to speak at 1:05pm CET. Despite the ECB’s reluctance to commit to further easing measures, with another 31 basis points of easing already priced in for this year, the central bank may adopt a firm stance in the short term to mitigate the weakening euro’s potential impact on the disinflation process.

The exchange rate is now facing strong resistance at the 1.0800 level, reflecting the market’s response to the confluence of political and fiscal uncertainties in France.

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