After credit rating agency Fitch downgraded France's sovereign credit score to the country's lowest level on record, stripping the euro zone's second-largest economy of its AA- status, there’s mounting speculation that if other agencies follow, it could trigger forced selling on French bonds bound by ratings thresholds.
With bond markets watching closely, there’s growing pressure on recently appointed Prime Minister Sebastien Lecornu to find ways to shrink the ballooning debt budget deficit next year from an estimated 5.4% of GDP, when he hands down his draft 2026 budget on 7 October.
Fitch attributes its A+ downgrade, the lowest on record for a major credit rating agency, to France’s “high and rising debt ratio” and lack of "a clear horizon for debt stabilisation in subsequent years".
In addition, Fitch forecasts that French debt would increase to 121% of GDP in 2027 from 113.2% in 2024.
Fitch also warned that “political fragmentation” was hindering fiscal consolidation.
"This instability weakens the political system's capacity to deliver substantial fiscal consolidation," Fitch said in a statement.
On Monday morning, the yield on France’s benchmark 10-year government bond initially moved 7 basis points higher to 3.5132%, while the yield on the 30-year bond, or OATs as they’re called in France, rose 8 basis points to 4.3351%.
However, France's downgrade to A+ is not expected to pressure the country’s major banks, with BNP Paribas and Credit Agricole already rated A+, with Societe Generale rated slightly lower by Fitch.
While the downgrade was already priced into markets, it underlines growing investor concerns over the French government’s ability to rein in its budget deficit - now the highest in the eurozone.
President Emmanuel Macron this week tapped conservative loyalist and former Defence Minister, Lecornu, to form a government after lawmakers ousted veteran centrist François Bayrou in a confidence vote following his plans for a 44 billion euro ($52 billion) budget squeeze.
However, there was no honeymoon period for Lecornu, with protests erupting on the day he was sworn in as PM, with more union-backed demonstrations due this week.
As Macron's fifth prime minister in less than two years, Lecornu has been tasked with delivering a slimmed-down budget through parliament, something his last two predecessors were axed for trying to achieve.
French debt has come under greater pressure since Bayrou called the confidence vote last month, which drove borrowing costs close to those of Italy, which carries the euro zone's second-highest debt burden and a much lower credit rating.
To win sufficient parliamentary support, Lecornu is expected to make concessions to the Socialists, including higher taxes on the wealthy and softening Macron's hard-won 2023 retirement reform.
However, he risks alienating lawmakers in Macron's own party and the conservative Republicans if he goes too far.
Meanwhile, analysts note that while Fitch’s downgrade was largely priced into French debt markets, future downgrades are expected.
“French sovereign bonds have been trading at spreads to swap rates consistent with multiple downgrades,” analysts at ING said in a note on Monday.
One of Lecornu’s first moves has been to abandon plans to eliminate two public holidays, as the new PM tries to dispel some of the political wrath targeted at his predecessor’s proposal — just one part of Bayrou’s unpopular cost-cutting plans.
