France's political and fiscal instability is emerging as a new risk for financial markets. With large-scale protests coinciding with a stalled budget process, the yield on France's 10-year government bond has climbed above 5%, and its spread over German bunds has widened to the highest level since 2011, the peak of the southern European debt crisis. The concern is that political conflict will derail fiscal consolidation, and that this will spread through the bond market and financial institutions to the eurozone as a whole.
France's fiscal vulnerability is not solely the result of temporary political turmoil. Its budget deficit has exceeded 5% of gross domestic product and its public debt ratio has risen to 119%, far above the eurozone fiscal rules of 3% and 60%. The European Commission projects that the deficit will widen to 5.7% in 2027 and that the debt-to-GDP ratio will top 120%. Interest costs are rising amid low growth, while social resistance to spending cuts and tax increases remains strong. Political disorder is likely to persist through the year-end budget deadline and the presidential election in April or May next year.
It is difficult to conclude that France's external soundness has reached crisis levels. Its current account deficit is expected to amount to just 0.7% of GDP in 2026, and fiscal balances have improved in most eurozone countries. The link between government bond yields and the banking sector also warrants attention. When yields rise, banks face larger valuation losses on bond holdings and higher funding costs, which can hurt the real economy through measures such as reduced corporate lending. French banks, however, have low exposure to their own sovereign debt and only a limited portion is marked to market, so the direct impact on capital is expected to be modest.
Whether France's fiscal strain spreads to other vulnerable countries is also important. High oil prices and high interest rates, driven by war, energy shocks and supply chain disruptions, work against heavily indebted countries. Italy and Spain in particular have high debt ratios and their banks hold large shares of domestic government bonds, so any contagion could amplify risks. So far, however, there has been no across-the-board spread of the kind seen in 2010-2012 or in 2022. The fact that the European Central Bank has response tools such as the Transmission Protection Instrument (TPI) is also more favorable than in the past.
France's current situation is closer to a political crisis than a financial one. Money pulled out of French government bonds is estimated to have moved into German bunds or high-grade corporate debt. The decline in U.S. and Japanese government bond yields on safe-haven demand also shows that global financial markets are absorbing part of the shock. Ultimately, if politicians put together a credible fiscal plan, the risk premium on French government bonds can stabilize. Conversely, if the political deadlock drags on and rising yields keep worsening the fiscal position, financial instability could deepen. The delay in reaching a political solution is itself a factor that amplifies volatility in financial markets.