France: Facing Headwinds

France’s economic and fiscal outlook has weakened through 2026 so far, with growth falling short of expectations and the public deficit set to exceed the government’s initial target. Political uncertainty surrounding the 2027 budget is also adding complexity to the fiscal consolidation process. These developments have contributed to a significant widening in French government bond spreads. However, the recent move has also taken place against a broader global rise in government bond yields.

In their recent webinar, Cyril Regnat, Head of Markets Research; Hadrien Camatte, Economist for France, Belgium and the Euro area; Benoît Gérard, Rates Strategist, and, Théophile Legrand, Rates Strategist, discussed their outlook for France, market risk and whether it is already reflected in current market pricing.

France entered 2026 with modest growth expectations, but economic activity has been weaker than anticipated. The current forecast is for French GDP to grow by 0.5% in 2026, compared to the expectation of around 1% at the beginning of the year. This annual growth forecast compares with 0.9% for both Germany and Italy, 2.5% for Spain and around 1% for the euro area.

The outlook for the second half of the year is somewhat more constructive, with quarterly growth expected at around 0.2% in both the third and fourth quarters. This would imply a continuation of weak growth rather than a recessionary scenario.

Several factors have contributed to the deterioration in the outlook. Higher energy prices following developments in the Middle East are one of the main factors. A €10 increase in the price of a barrel of oil could reduce growth by approximately 0.1 percentage point after four quarters, and increases inflation by around 0.4 percentage points. With oil prices having returned to around $92 per barrel, the energy shock represents a significant additional constraint on the French economy.

The fiscal response has also been more limited than in some other European countries. With France already running a deficit above 5% of GDP, the scope for additional fiscal measures to offset the economic impact is constrained.

Weather conditions have provided another temporary drag; France experienced a particularly hot summer, with a high number of days recording maximum temperatures of 35 degrees Celsius or above. The resulting impact on agricultural output is estimated to reduce annual growth by around 0.1 percentage point.

Public works and civil engineering activity have declined sharply too. The timing of municipal elections led local authorities to delay investment, creating an additional, and specifically French, source of weakness.

While the government initially targeted a public deficit of 5% of GDP for 2026, following a deficit of 5.1% in 2025, it now expects the deficit to reach 5.4%. Part of the deterioration reflects weaker economic activity and consequently lower tax receipts. The labor market is also slowing, with the unemployment rate expected to rise above 8.6% by the end of the year.

Higher debt-servicing costs are another important factor. Interest payments on general government debt represented around 2.2% of GDP in 2025 and are expected to exceed 2.5% in 2026. Based on futures markets, Natixis CIB Research expects this figure to exceed 4% by 2030.

The increase in borrowing costs is particularly relevant because higher interest rates make the fiscal adjustment required to stabilize the debt-to-GDP ratio more demanding.

For 2027, the government has announced a €54 billion fiscal effort, with the objective of bringing the deficit back to 5% of GDP. The figure represents an adjustment relative to the projected trajectory of public finances rather than €54 billion of direct spending cuts.

Without measures, the deficit could reach around 6.4% of GDP in 2027.

The government’s proposed measures include a freeze on state spending outside defense, a public-sector wage freeze, savings related to sick leave, a freeze on certain income-tax thresholds and partial freezes to indexation. However, the full package has not yet been itemized, and more detail is needed before assessing the credibility of the consolidation plan.

The government is also working with a 2027 growth assumption of 1%, compared with Natixis CIB’s forecast of around 0.8%.

The 2027 budget process is taking place against a highly fragmented parliamentary backdrop. There is currently no stable majority in parliament, while recent budget processes have been marked by significant political uncertainty.

Several possible outcomes have been identified, including the passage of a full budget, a special emergency finance bill that would delay the full budget until the following year, or the potential use of executive ordinances.

The latter option would be unusual for a budget and would involve additional constitutional considerations. If used, it would only become possible after the parliamentary process had run its course, potentially extending the period of uncertainty into December.

The budget timetable is particularly relevant because it overlaps with the rating agencies’ assessment of France.

Scope Ratings recently downgraded France to A+, while Natixis CIB Research expects upcoming reviews from S&P and Moody’s to remain important for the market. Fitch maintained a stable outlook at its August review, although further changes to the rating outlook cannot be excluded depending on developments in growth, the deficit, the 2027 budget and the presidential election. With public debt expected to exceed 120% of GDP next year, rating developments are likely to remain closely linked to the government’s ability to demonstrate a credible path towards fiscal consolidation.

The widening in the OAT-Bund spread needs to be considered against a broader rise in global and European government bond yields. The spread between the 10-year French OAT and German Bund, which stood at around 60 basis points in early June, widened to around 75–80 basis points in August and has since moved towards 105 basis points.

This move reflects both France-specific and global factors. On the domestic side, weaker growth, the higher expected fiscal deficit, political uncertainty and concerns around the 2027 budget have increased the risk premium investors demand for French government bonds. The broader rise in sovereign yields has also played an important role. The 10-year US Treasury yield has moved towards 5%, while the German 10-year yield has reached its highest level since 2009. Geopolitical developments and higher energy prices have also contributed to the global rates backdrop.

The OAT-Bund spread therefore does not represent a pure measure of French political risk. Natixis CIB Research estimates that roughly 40 basis points of the current 10-year spread can be attributed to France-specific factors. This suggests that a significant part of the additional risk premium is already reflected in French government bond pricing, while further movements will depend on both domestic fiscal developments and the broader direction of European rates.

The assessment presented during the webinar is that French-specific risk is already significantly reflected in market prices. French government bonds also screen as relatively inexpensive against several valuation measures, including comparisons with swaps, German Bunds and Italian government bonds.

This does not remove the risks associated with the fiscal and political outlook. Rather, it means that the evolution of spreads will depend increasingly on whether subsequent developments provide greater clarity around fiscal consolidation, the budget process and the political environment.

Natixis CIB’s baseline scenario sees the 10-year France-Germany spread at around 95 basis points at year-end, before moving towards 75 basis points as rating-related uncertainty normalizes. Volatility is expected to remain elevated, with risks remaining sensitive to political developments. A more adverse scenario could result in further widening, particularly if the budget process produces limited fiscal consolidation or if political uncertainty increases.

For the French sovereign market, the coming months are therefore likely to remain focused on the interaction between three factors: a subdued economic outlook, the government’s ability to deliver fiscal consolidation and the broader global rates environment. At current spread levels, it appears that French-specific risk has already become a significant component of market pricing, making the subsequent evolution of fiscal and political developments particularly important for the direction of the market.