France's legislative election result risks political chaos
Euro Macro: Last night's legislative election results in France were clearly a big surprise, with the left coalition coming in first place, while the far-right alliance, which dominated the polls for weeks and won the first round, ended up in third position. The Centrist alliance performed better than expected, securing 168 seats, more than double what the polls were previously suggesting.
As such, no clear winners really emerged from this result, as the three political blocs are well below the absolute majority of 289 seats. This forces the political parties to extend their alliances to govern. Although it is a common political practice in most European countries, it is an uncommon situation in France since the establishment of the Fifth Republic. Therefore, this will require a lot of negotiations in the upcoming days and even weeks in an attempt to form a coalition government. This will indeed be very challenging given the strong political divisions and disagreements within their own alliance as well.
Based on the new composition of parliament, only one credible coalition emerges, which is a Centrist alliance extending to the Socialist Party (PS) and the conservatives (Les Républicains). However, while this coalition may gather enough seats to achieve an absolute majority, it will require nearly unanimous support from each party, which appears uncertain at the moment. In addition, it is doubtful whether PS would work with LR. Another coalition is unlikely, as it would necessitate an alliance with one of the radical parties (RN or LFI), a prospect that was already rejected by their political leaders last night.
Even in the scenario where a so-called National Union emerges, it is likely to be based on a "minimal" political program, as previously mentioned by former socialist President François Hollande. This means that the different parties could agree on a few political points but unlikely to engage any important political reforms, given their strong divisions on economic issues.
In the meantime, the NFP coalition is currently discussing a potential Prime Minister and aims to announce their candidate by the end of this week. As the NFP is the largest party in parliament, it is possible to have a minority left-leaning government, at least in the short term after July 18th. However, in our view, this type of government is unlikely to last, as it will likely face a vote of no confidence the moment they attempt to implement some of their controversial political measures.
Therefore, this political situation is likely to result in a hung parliament where no government can be formed, potentially leading to a technical government for a year until a new legislative election.
Market reassured as radical parties fall short of majority
Despite the remaining political uncertainty, markets responded positively to the recent political outcome, with French sovereign spreads tightening in today's session. This positive trend also led to a rally in other EU countries, with Italy returning to spread levels seen before the election announcement. This outcome has provided short-term relief to the market by eliminating the possibility of radical parties coming into power, likely leading to a status quo for at least another year.
However, the relief in the financial markets following the recent political outcome is unlikely to see a complete retracement of France’s sovereign spread, which we expect to remain at elevated levels. This is because while political gridlock may prevent the kind of fiscal largesse that markets had been fearing, it also means that fiscal consolidation will be limited. Given that France already has one of the largest budget deficits in Europe (see graph below), it means that the country’s creditworthiness will deteriorate. In addition, the country looks like it is heading for a clash with the Commission, given it is "in excessive deficit" and might be unwilling/unable to set out a credible plan for deficit reduction. On the other hand, the ‘gridlock’ scenario will probably not be one that sends shockwaves through financial markets more widely.
Looking further forward, a new legislative election likely next year, due to the absence of a majority by any political party, could lead to a new flare up of tensions. We therefore expect country spreads to widen again as we approach the second quarter of 2025, when a dissolution of the assembly is likely to be announced once more, triggering a new round of political risk.
