Paul Diggle
Hello and welcome to Macro Bytes the economics and politics podcast from abrdn. My name is Paul Diggle
Luke Bartholomew
And I'm Luke Bartholomew.
Paul Diggle
And this week we are talking about French politics, Macron’s gamble in calling snap parliamentary elections and France’s economic and the fiscal situation. We're going to talk about the excessive deficit procedure just opened against France, what the European Central Bank is thinking and could do during a period of market stress and why and indeed whether markets should be worried by all this. So there's a lot to get into. I'm joined by Lizzy Galbraith, political economist at abrdn and Felix Feather, European economist at abrdn. Welcome Lizzy. Welcome Felix.
Lizzy Galbraith
Good to be back again.
Felix Feather
Hi, Paul.
Paul Diggle
So, I should say before we get going that we're speaking on Tuesday, 25th of June, so about five days out from the first round of the election on Sunday the 30th. And there will be a second round runoff for all parliamentary candidates polling above 12 and a half percent in a particular constituency. So in just over a week and a half we'll know the final makeup of Parliament, but we're going to have a good idea of what's going on before then. So Lizzy, let's start then by talking about the gamble that Macron took in calling these elections because it was a bit of a surprise calling snap parliamentary elections several years ahead of schedule. They came after European Parliamentary elections in which Macron’s Renaissance party underperformed. Marine Le Pen's National Rally did well. What was the political calculation or gamble that Macron was making? And why has it seemingly not paid off?
Lizzy Galbraith
Yeah, so snap elections in France are a relatively rare occurrence. It's not the first time this has happened, but it's certainly not as frequent a feature of French politics as it is for let's say British politics, for example. They tend to be much rarer. So this is definitely something that we weren't really expecting. No one was particularly prepared for a snap election to be called, particularly, as you mentioned, after fairly difficult European Parliamentary elections for Macron’s party. They came in a relatively distant second to Marine Le Pen's party. So this election largely seems to have been called, partly in recognition of the fact that Macron was actually heading into quite a difficult autumn anyway. He didn't have a majority in the parliament to begin with, and it was looking like it would be very difficult to pass a 2025 budget as things stood. And it's also probable that what he was looking to do was actually take advantage of that fairly poor results, and hope to galvanise the voters that didn't support LePen, into coalescing around ideally his own centrist coalition. Now, the problem with that has been that Macron is personally very unpopular, and he has proven unable to coalesce that vote around his own party. And instead, it seems to be mostly going in the direction of a newly established coalition of a number of left-wing parties across the political spectrum. And crucially, it also seems like Marie Le Pen's party National Rally is holding on to the vote share that it started this election campaign with - so it hasn't been damaged by this snap election. If anything, it actually feels like it's Macron that is going backwards here rather than his main rivals.
Paul Diggle
And there’s this history in France, isn't there, have forcing a choice on the voters often say in the second round of a presidential election between a centrist figure and Marine Le Pen, or her father before her. And there's in the past been this kind of eventual return to the centre ground cordon sanitaire around the right in France, but that bring it to a head, force of choice on the voters logic. Interestingly, also Rishi Sunak’s logic in the UK, it’s just this time around, it may not be paying off.
Lizzy Galbraith
No. And I think what really changed here is that Macron was betting on the left-wing parties in France staying divided. There's four or five of them of them. And instead of remaining relatively divided as they have been for the last few years, instead, they've decided to form a fairly loose coalition, but an electoral coalition nonetheless. And that has become a very effective way of actually pushing Macron into a pretty consistent third in the polls. So in this situation where Macron is trying to force a choice, actually he has had the effect of forcing a choice between the right with Marine LePen and this new left- wing coalition. So, he's been made a victim of his own political system in a way because of the events that we've seen since the snap was called.
Luke Bartholomew
So notwithstanding the failure of that gamble Lizzy, polling is currently pointing towards a hung parliament rather than a National Rally majority, I think it's fair to say, or some form of minority government and markets seem to be taking a little bit of comfort, perhaps from the idea that there'll be policy paralysis in such a minority or hung parliament kind of situation. So is the market correct to think that such a minority government wouldn't get much done and would effectively defang National Rally or is there still a possibility that regardless of other differences between left and right, there is still a majority, potentially for quite expensive fiscal policy? So even in a minority government, a number of policies that the market wouldn't find particularly friendly could still get passed?
Lizzy Galbraith
Yeah, I think an important caveat to any discussion about the polls is that because France has a two phase electoral system, it's quite tricky sometimes to actually translate these polls into seat projections. So’ our base case is, as you say, a hung parliament. It doesn't look like any one party is going to be able to clear that hurdle into a majority. But the nature of the French electoral system means that we can't completely rule it out. It largely depends on all of these individual races, and which parties end up in the second round. So with that caveat out of the way, yes, we do think that it's a bit too high of a bar to clear for any of these parties to secure a majority. But I wouldn't necessarily say that a hung parliament is an entirely risk-free prospect. It's not without its own risks, not least that a hung parliament is likely going to be unable to enact the necessary fiscal consolidation that certainly President Macron thinks France needs, as does the EU. So we will see policy stasis, but that is not without its own drawbacks. France would be would be left in this situation for at least another year until a second snap, if required, would be able to be called. So there are fiscal issues here. I think there's also some possibility that some of these fiscal promises are actually able to be enacted. There's possibly, across across the right and the left a majority for say repealing and Macron’s pension reform. Whether or not these parties can actually work together in practice, I think is a very big if. But technically, they are all in favour of repealing this reform. So it's not off the table that we do get some of these measures actually introduced. But I think any hung parliament would find it very, very difficult to pass legislation in practice.
Luke Bartholomew
And you say we don't want to rule out entirely the possibility of a majority government. I mean, do we have a sense of the kind of likelihood of a National Rally majority or even a new Popular Front majority? And are we right in thinking there's essentially zero chance of Macron’s party leading the government in any way at this point?
Lizzy Galbraith
I think it does seem like Macron’s chances are certainly fading. He was probably in any situation going to be relying on some form of coalition arrangement bringing in some of the other centrist parties. And they have all largely taken alternative directions over the course of this campaign. So it does look like there is a vanishingly small chance of Macron retaining any form of control over the parliament after this election. The polls would suggest that it's National Rally that would be the favourites to form a majority, if that's the outcome we're looking at, but it certainly seems like it is a bit of a high bar. Certainly, maybe a 30% chance, roughly speaking, and less than that for the new Popular Front, owing to their consistent polling behind National Rally overall. So it's absolutely not our base case that that happens. But I think it's certainly not something that we can rule out. Again, the polls are still coming in, we're still seeing shifts as this race unfolds, and the seat allocation will remain fairly unpredictable until we get to the seventh of July.
Paul Diggle
So fiscal policy, as we've been saying, is the locus of some market concerns around this election. You've mentioned Lizzy proposals on both National Rally and New Popular Front to undo some of the pension reforms that Macron undertook. So this would effectively lower pension age back down to 60 in some cases in France. What are the other fiscally expansive policies that those parties have been talking about?
Lizzy Galbraith
So I think one of the relatively unique circumstances of this is that both of these two main coalitions actually have adopted really quite fiscally expansive policies. And we've already spoken about maybe the barriers on their ability to enact those. But one other thing that it's worth noting is that National Rally have been moderating their policy platform quite significantly over the course of this race, it's changed quite a lot from the platform that they ran on in the 2022 presidential election, which was much more expansive. What we've seen over the course of this race is them essentially putting a lot of these policy proposals on hold. However, we do still have some pretty chunky spending pledges, still there. So reducing VAT on energy and fuel costs, for example, that will be paid for by a series of tax increases on shipping companies, energy companies, as well as potentially quite controversially, cutting France's contribution to the EU budget. So yes, there has been some moderation in National Rally’s policy platform, in some cases, just not actually saying when they're going to introduce some of these policy platform pledges. But I don't know if this is necessarily a credible pivot from them, given that they are still going to have one eye on the presidential election in two years’ time. And they are they are going to want to, you know, retain this very broad electoral appeal that they have got through those expansive policies. So they're going to be walking a real tightrope here between trying to look like they're moderating, like they're ready for office, but also trying to retain that very broad appeal that those policies brought them in the first place. Now, New Popular Front is in a bit of a different position on paper it's actually the more fiscally expansive of the two now, given National Rally’s moderation. So they have policies, in addition, as you've mentioned, to repealing Macron’s pension reforms. They also want to enact a lot of policies aimed at addressing the cost of living in France, so increasing public sector pay, subsidising energy costs, for example. And unlike National Rally, these new policies are paid for by a series of really quite chunky tax increases. So of the two platforms, you may say that New Popular Front’s is the more costed, but it's also by far the more expansive of the two. And it would certainly not be compatible with any deficit reduction plans or expectations. So either one of these platforms would be quite difficult to see work in practice.
Paul Diggle
And talking of deficit reduction plans, then bringing you in Felix, important context here is that France’s fiscal situation was pretty challenging, even before we start thinking about the potential outcome of this election or what that could mean. Do you want to talk us through French fiscal dynamics and why France has is running such a large deficit?
Felix Feather
Yeah, it's a relatively difficult situation. That 2023 budget deficit number ended up coming in at 5.5% GDP. A few things to note about this number. One is that it's really quite high in a European context. This is the second highest budget deficit right now across the 20 countries that use the euro. It's also quite a lot higher than the government was hoping for. Around about this time last year the French government were hoping that that number would be more in the high fours than the mid fives. So it came as a real disappointment when those borrowing figures came out higher than expected. The third thing to note is that it's quite a lot more than 3%, which is, of course, the number that the EU nominally requires all its members to comply with - to stay under. There are currently some carve outs, which makes some exceptions, given that countries have gone through a big period of expansion in response to the COVID 19 pandemic, but also then the energy price shock of 2022. But these exceptions require countries to show that their deficits are on a clearly declining path, getting back to 3% within a reasonable timeframe. Because France's deficits have come in larger than expected, they can no longer credibly put forward plans that do have deficits coming under control within this timeframe, which is why the EU authorities have gone ahead and begun to open an excessive deficit procedure commonly known as an EDP against France. And this will require France to get together with ECB officials and come up with a deficit reduction plan, which will take deficits back into compliance territory over the medium-term, around about seven years is the new requirement under the reform to fiscal rules which took place at the end of last year.
Luke Bartholomew
And Lizzie one of the other things that investors have worried about with Marine Le Pen's political rise in the past has not just been about fiscal policy but about France's membership of the euro, so called ‘Frexit’ - French exit from the eurozone and the EU. Now I know that she has softened her line somewhat on the question of membership of various European institutions. So first of all, what is the current line on those questions? And second, is there a sense of sort of, regardless of how the rhetoric has shifted, just because of where they stand on questions of fiscal policy and migration and other that inevitably they end up picking those kinds of existential questions with the Eurozone anyway?
Lizzy Galbraith
Yeah, I think it's been dropped as a sort of explicit part of National Rally’s platform in recent elections, they're no longer explicitly advocating for a referendum on leaving the EU. But nonetheless, she does advocate for what she calls a different Europe, a different sort of alliance of nations now. So it's very much still quite a, you know, comprehensive altering of the relationship that France has with the other European nations. And they certainly continue to be resistant to expansion of the EU, particularly in terms of its competences and the areas that it has responsibility for. They’re fairly resistant, for example, to any additional role for the EU on defence policy, for example. So there are certainly still quite a lot of areas of potential conflict that a National Rally led government or presidency would have with the EU, not least in the context of this election, because of course, you still have Macron as president who has very different views. So you would have quite an inconsistent type of policymaking at a French level where Macron on the European Council would potentially be advocating for very different positions, compared to French ministers at the council body level, who would be appointed by, in this scenario, a National Rally led government. So there's a lot of complexity here. There are also a lot of points which potentially draw a French government into conflict with the EU, not least the excessive deficit procedure itself. We've spoken already about the potential for actually a National Rally led government to find it quite difficult to stick to some of these moderated fiscal policies that they've made. Maybe they go back to some of their previous pledges, or certainly don't consolidate in the way that they've implied they would do on the campaign trail. That would automatically raise tensions with with the EU and in that situation, it's quite difficult to see, from a political perspective, National Rally caving in to those demands, given their political platform and their stance ahead of the presidential election. So there are lots of points at which this could get quite complex from a political and a foreign policy perspective. Even if there's a parliament that actually in practice can't enact much in the way of legislation, there's lots of potential points of contradiction and conflict with between both Macron and and the European Union.
Paul Diggle
And Felix, when we think about market stress and worry about some of these questions, one key metric we look at is the OAT-bund spread - so the difference between the yield on French bonds and German bonds, the latter being thought of as the ‘risk free’ asset in Europe. So tell us about what that spread’s been doing, you know, set the set in context of previous Eurozone spread widening events, and then importantly, is that the market worrying about fiscal risks, or the sort of redenomination risks i.e. euro exit risks that we've just been speaking about, and how would we even figure out the difference?
Felix Feather
Yep. So these spreads widened quite a lot initially across a number of countries after the EU Parliament election results came in. But since then, it's been a much more France-centred issue. So historically, prior to the recent election, about 55 basis points was the spread between those French government bonds and the German ones. That widened to about 80 at its peak a couple of days ago, as of today, the 25th. That seems to be back down to 75, 76. So still a long way above where it was even a few weeks ago, even if it's come off it's real low. I think the answer to your question about whether this is about fiscal or redenomination risk, I think it's definitely fiscal. If this was a redenomination issue you'd expect to see probably more of a move in lockstep across a lot of different peripheral economies. Whenever redenomination risk becomes the key topic of conversation, there's always a concern about contagion between countries. Obviously, if there's a risk of one country exiting the euro and paying back its debt in its own national currency, there's a risk that this phenomenon will spread to other countries as well. What we're seeing right now is a lot more focused just on France, and it seems to be focused around the political risk for sure - but more broadly around that fiscal question. As we've heard, the results of the legislative elections could result in a lot more fiscal expansion. And as the polls have come in, these spreads have widened. That's pretty good evidence to me that it's the fiscal driver that's pushing these spreads wider. I think this serves as a reminder that these things really do matter. And when deficits get wider and wider it can increase the cost of debt pretty meaningfully, even within the EU where there's sometimes been support from the ECB for countries where spreads do widen.
Paul Diggle
Yeah, and it's worth saying that we can look at specific market instruments like credit default swaps CDS to get a bit of a read on redenomination risk, and those have risen a little bit, but they're still pretty contained. And this is more spread widening as term premia on French government bonds have gone up because the market is anticipating needing to digest more issuance of French debt, which would be the counterpart of a larger a larger fiscal deficit. But I want to then Felix talk about the European Central Bank's role in all this because the ECB has in the past been a very important backstop and support that can step into Eurozone sovereign debt markets in the event of more disorderly price action, real big spread widening, redenomination risk, should that eventually kind of enter the price. Why don't you tell us how the ECB is reading this current situation? And, in extremis, the sort of things it does, the sort of toolkit it has, to backstop sovereign debt markets in a genuine crisis.
Felix Feather
So I think recently one of the most important parts of the ECB’s toolkit which it has used in a similar situation to stop spreads widening, not in France, but in Italy, is this ‘transmission protection instrument’ as it's called, which is designed to make sure that monetary policy is passed through pretty evenly throughout the Eurozone. And the ECB can use this to make interventions through open market operations, to make sure that spreads are moving in an orderly manner. What it doesn't do is make sure that spreads are even across all countries, they can move, and they will let markets move those spreads around in response to fundamental economic drivers. But that last point is really important. It's got to be fundamental economic drivers that the market is citing when it is making these repricing movements. At the moment the ECB seems to be content that these market fluctuations are indeed related to fundamental drivers. And I would tend to concur with that. The fiscal situation, as we've already discussed, seems to warrant a higher spread of OATs over Bunds. So the ECB is quite happy to take a hands-off approach there and let this little bit of weakness run its course. It's worth noting that certainly that these aren't massive moves on the scale that we've seen the ECB respond to with intervention before. Certainly when you compare the scale of spread widening in France today to the height of the euro crisis or widening in Italian spreads in 2022, it's not on the same order of magnitude. So, I think you'll see the ECB stay out of this one, as long as there isn't a meaningful change in market action or redenomination risk coming into play, for now quite content to let those spreads widen just a touch.
Luke Bartholomew
And then another comparison, Felix, outside of what happened in Italy that's been made by no less authority than the French finance minister himself, is the so called ‘Liz Truss moment’ of 2022 when of course the ‘mini budget’ faced extremely adverse market reaction, which then led to the fall of the government and the collapse of that fiscal plan, as well. So how appropriate are those kinds of comparisons between, I suppose, France and situation now, or indeed France’s situation on the other side of this round of elections, and where the UK was at in 2022?
Felix Feather
It's similar in a sense that it's the likelihood of fiscal expansion increasing and the market responding accordingly. But where it's very different is that the scale of the sell-off in response to the mini budget is so so much bigger than what we've seen in the in French markets so far. That's not to say that we couldn't in the future get something in France of a mini budget type scale. But it would need some pretty surprising election results, and it would need a change in the political order. I'm not sure we're going to see it in the next few weeks, I don't think a change in control of the legislature is going to be enough to trigger that kind of reaction. As Lizzy’s already discussed, there's going to be pretty limited legislative power in the hands of whoever comes out on top of French legislative elections. So I’d stop short of any direct read across for that reason. It's also worth remembering that the macro backdrop is very different to where we were in the autumn of 2022. This was a time when interest rates were rising. Inflation was very, very high indeed. And this proved a particularly unfavourable cocktail for the sort of fiscal expansion that Liz Truss was planning. So I suppose in a really bad scenario, you could end up with that mini budget-style market sell off in France, but we're not there yet. And it would require some results that would surprise us. Certainly the hung parliament sort of scenario where you get policy stasis wouldn't trigger this sort of 100 basis point rise in yields which is what you got after the mini budget was published.
Luke Bartholomew
I suppose one difference that might make the UK case slightly more favourable, actually, is that whatever else the Westminster parliamentary system has going for it, it is very easy to get rid of failing governments. So that should fiscal policy get very adverse market reaction, politics can deal with that reasonably quickly and ruthlessly. Perhaps that could be a little bit harder in the French system where constitutionally there are limits on calling further elections and changes in government. But not withstanding that, I suppose, even the threat of this kind of ‘Liz Truss moment’, you don't need the market to do that for that to discipline politicians. The very fact that that's a risk out there, they've seen something similar to that in the last few years could be enough to stay the hand of some of these fiscal plans for now, indeed, arguably that was sort of what was on in the mind of someone like Meloni in Italy and partly explains why the kind of policies that she's been pursuing there have been slightly more quote unquote ‘orthodox’. So Lizzy, I wonder what are the chances of something like that turn to orthodoxy in France as well? Might Le Pen do a Meloni?
Lizzy Galbraith
So I think the possibility is there. But it's not necessarily the base case that I'd have in the event that you did have a National Rally majority. So there's a couple of situations in which that could be possible, particularly one in which National Rally is able to cobble together some form of coalition arrangement with some of the smaller parties. And that sort of de facto moderates the ability to pass legislation. But the big difference, I think, between the situation that we have in France and Meloni, is that Meloni already secured effectively the top job, she had already got to the sort of peak of influence over Italian policymaking, whereas for National Rally, the big prize continues to be the presidency. And that remains so far out of reach. We're not going to have those elections for another two years. And the argument against really moderating after these legislative elections, even if in the event that they can actually introduce policy is that you still have that bigger prize of the presidency up for grabs, and you therefore will want to keep that in mind when making these legislative plans. So I think, given the base that National Rally have, given what we know National Rally voters actually advocate for, want from their politicians, it feels less likely to me that certainly in the next two years we see that kind of Meloni style policy moderation. It may happen to a certain degree, but I think there's a lot that is sort of core to the current National Rally policy platform that they will be very, very reluctant to remove in advance of those elections.
Paul Diggle
Okay, well, I think that's all we have time for today. There's clearly plenty more room to run on this story going forward. No doubt we'll return to it on a future episode of Macro Bytes but for now let me thank Lizzy and Felix for their contributions. Thank you for listening to Macro Bytes. Please do like and subscribe on your podcast platform of choice. But until next time, goodbye and good luck out there.
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