While the main political problem in the United States is the inability – or rather lack of will – of Democrats and Republicans to reach a budget agreement, which has led to another government shutdown, Europe’s biggest concern remains France, where another prime minister has resigned, less than a month after taking office.
Markets reacted accordingly, with the euro falling against the dollar, as did the French CAC 40 index and the Euro Stoxx 50, while yields on French and German government bonds rose. On the other hand, gold (XAUUSD), the traditional safe haven, saw a further rise, approaching the $4,000 mark.
Why don’t French prime ministers stay in office?
To understand the scale of the problem, the country has just lost its fifth Prime Minister in just two years. So, even if Monday’s resignation is not really surprising, it has reinforced the feeling of prolonged political instability, which does not reassure investors, particularly those holding French sovereign debt.
At the heart of the problem lies the government’s inability to address France’s fiscal imbalance. The budget deficit currently stands at around 6% of GDP, double the EU limit of 3%. Public debt has reached around 114% of GDP, well above the threshold recommended by the EU.
It’s not that there are no ideas to solve the problem. The solution is simple: raise taxes and cut spending. This is precisely what François Bayrou’s initiative proposed, aiming to drastically reduce the deficit from 5.8% in 2024 to less than 4.6%. However, he ended up facing a vote of no confidence.
In addition to obstacles posed by opposition parties, any reform efforts aimed at reducing fiscal spending face fierce public resistance. The fundamental question is therefore how to cut spending or raise taxes enough to balance the budget without triggering a new social crisis that could harm the country’s growth.
Is the euro in danger?
In theory, if the impasse persists, not only could rating agencies further downgrade France’s credit rating, further increasing funding costs, but the crisis could eventually spread to the bloc’s financial sector, causing capital outflows, higher inflation, a weaker euro, judging by the EURUSD chart, and a fall in EU markets.
However, much will also depend on the development of the US dollar and the outlook is not very promising at the moment. In addition to the government shutdown and expectations that the Fed will continue to cut interest rates, U.S. debt and lingering trade tensions could continue to weigh on the dollar in the long term.
