Fitch has downgraded France’s credit rating from AA- to A+, deepening the pressure on new Prime Minister Sébastien Lecorn and financial markets after months of political crisis. Key justifications for the decision include rising debt, the highest deficit in the eurozone, and ongoing political instability, preventing effective implementation of plans to consolidate public finances. Fitch forecasts a further increase in public debt, which could reach 121% of GDP by 2027, and the lack of prospects for a parliamentary majority weakens the government’s chances of implementing budget reforms.
The market reaction was a rise in French bond yields and a moderate widening of the spread against German paper to 81 basis points – a level last seen in January.
Source: worldgovernmentbonds
While we can infer from the markets’ scant reaction that the downgrade was largely already priced in and need not trigger a sharp sell-off, the problem for France remains the lingering political risk premium. Investors are expecting concrete action from the new government, which, in order to pass the budget, will have to seek agreement with both the center-left and center-right, without losing the support of its own base.
In the longer term, Fitch warns that if the political impasse persists and the path of fiscal consolidation is diluted, France could lose its unique position among eurozone debt issuers – less risky than Italy, but not as safe as Germany or the Netherlands. More rating revisions are coming soon – if other agencies follow Fitch’s lead, the risk of forced sales of French bonds by some institutional investors will increase, and higher debt-servicing costs will begin to weigh on economic growth in real terms in future years.
We don’t see any negative sentiment related to Fitch’s decision at the moment, and paradoxically the FRA40 contract is clearly gaining today, which may indicate that the downgrade was expected by the market. Technically, the contract remains above both the 50-, 100- and 200-day exponential moving averages, which raises the prospect of initiating a more sustained uptrend. However, risks to the index remain relatively high. Source: xStation
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