France heads to the polls amid economic uncertainty and investor caution

The elections planned for Sunday in France are in a tense political climate. It is undecided whether Emmanuel Macron will continue to govern the country or if more eurosceptic factions will take over. The latest economic signals confirm that France is in a phase of evident slowdown. Can this affect the election outcome?

The French economy has had another challenging month. The main PMI indicator level fell to 48.2 in June from 48.9 points recorded in May. This means the French economy is again moving away from the 50-point line that marks the boundary between recession and recovery. Another drop in new orders recorded in June casts doubt on the results for the second-largest economy in the eurozone at the end of the year's first half. As in the case of Germany, after the April revival, Paris is struggling with a decline in economic activity in industry and services, according to the latest S&P data.

Norman Liebke, an economist at Hamburg Commercial Bank, forecasts that the French economy will likely grow by just 0.1% in the second quarter of 2024.

He also explains that the forthcoming parliamentary elections scheduled for Sunday could contribute to the slowdown in business activity.

The uncertainty associated with the upcoming elections is causing French companies to hold back on investments and prepare for tougher times. According to some respondents, the lower level of activity was directly linked to the upcoming elections, explains Liebke, as quoted in an S&P report.

It is not just French entrepreneurs who are waiting. As Bloomberg notes in its commentary, the early elections to the National Assembly in France are being closely watched by investors. This is evidenced by the spread between German and French 10-year bonds, which has reached its highest level since 2012. One post-election scenario is a sharp increase in France's debt.

The election outcome on the Seine does not necessarily have to be straightforward. Experts consider a political stalemate to be the most likely scenario. The National Rally will likely win the most seats in the National Assembly but will not obtain a majority.

The second scenario is one in which the far right wins enough votes to form a government, forcing President Macron into cohabitation. The bond market's reaction will depend on the rhetoric adopted by the new government.

The third possibility, considered by experts to be the worst from the investors' point of view, is an unexpected victory of the New People's Front. Such an outcome would most likely lead to a significant increase in the yields of French government bonds.

The last, though currently the least likely, scenario is President Macron's party and its allies maintaining the position of the largest party in parliament. For the bond market, this would probably be the best election result.

France, as one of the most developed countries in the world, is characterised by a high level of budget expenditure, particularly in the area of social benefits. According to OECD data, in 2021, France's public spending constituted 59.2% of GDP, placing it in fourth place among the organisation's member countries.

A significant portion of these expenditures is comprised of social transfers, which in 2020 amounted to 23.4% of GDP, one of the highest results among OECD countries. France also allocates significant funds to education—in 2020, public expenditure on this sector accounted for 5.4% of GDP, exceeding the OECD average of 4.9%.

Regarding defence spending, France allotted 1.9% of its GDP in 2021, making it the third-largest NATO country in terms of defence budget in absolute values.

France's average annual GDP growth is 1.1%. At the same time, France's deficit has been 5% of GDP since 2019. Therefore, this spring, the government announced significant cuts amounting to GBP 9 billion.

Bruno Le Maire, the French Minister of Economy and Finance, criticises Macron's decision to hold early elections and is concerned about its consequences. In an interview with Le Monde, he expressed concern that an extreme victory would lead to a financial crisis.

"The French economy is solid. We put it back on track. However, we have a financial situation that should lead us to make savings, so we can invest and reconstitute margins for maneuver in the event of a new crisis," he said.

"Yet the platforms of both the far left and the far right are financially unbearably careless. Our creditors and the markets have understood this. For the past two years, the spread between French and German 10-year yields, a measure of investor confidence in France, has been stable at 0.5%, thanks to a strategy for restoring public accounts deemed credible. Since the oppositions have presented their platforms, this spread has jumped to 0.8%, the highest in seven years. France is now borrowing at a higher rate than Portugal. And we risk rapidly paying more than Spain. The extra 0.3 percentage points means €1 billion in additional expenditure per year for the state, and 5 billion in five years," he argued.

A comparison of the growth dynamics of real gross domestic product (GDP) of the five largest economies in Europe from 2011-2021 shows their diverse development paths. Eurostat data shows that the United Kingdom recorded the highest average annual GDP growth rate in Europe (1.9%), ahead of the other leading European economies. Germany, the largest economy in Europe, achieved an average annual growth rate of 1.5%.

According to current polls, Marine Le Pen's far-right National Rally enjoys the highest support—34.2 %. The left-wing coalition New People's Front is in second place with 28.2%, while President Macron's camp is in third place.