France's fresh budget battle threatens to topple another government

France is paying an ever-higher risk premium on its debt as investors brace for a third straight year of drama over its annual budget, which threatens to topple yet another leader.

The yield on the country's 10-year government bonds — known as OATs — popped above 4.5% on Friday for the first time since 2008, and has since held above that threshold. It was last seen trading with a yield of 4.6696% on Thursday.

France's 10-year yield is now more than one percentage point higher than the payout on German 10-year bonds for the first time since the height of the euro zone sovereign debt crisis in 2012. The market continues to demand greater compensation for lending to France than it does to Italy or Greece — the problem children of the crisis.

Further across the yield curve, France has some of the highest government borrowing costs in the G7 group of advanced economies.

French Prime Minister Sébastien Lecornu's fragile minority government will submit a draft proposal for the 2027 package to parliament in early October, which will be debated through the month ahead of a Nov. 17 vote.

Lecornu has said he will target 54 billion euros ($61.8 billion) in spending cuts, insisting that greater fiscal discipline is needed to quell France's ballooning debt load and reduce one of the euro area's biggest budget deficits. Some economists say France is on an unsustainable path after Fitch's downgrade of the country's credit rating last year.

On Saturday, the French finance ministry said it expects national debt to reach a record high of 119.3% of gross domestic product in 2026, with a projected debt-to-GDP ratio of 121.7% in 2027.

But ever since France's July 2024 snap election failed to deliver an absolute majority in parliament, political division in the National Assembly — which includes the far-right National Rally, the left-wing New Popular Front and Lecornu's center-right grouping — has come to a head over budget disputes.

Administrations were ousted in no-confidence votes in December 2024 and September 2025, while it took Lecornu until February this year to pass the 2026 budget via a constitutional clause allowing him to bypass parliament.

"A tough draft budget for 2027 risks toppling the government despite a widely held desire to avoid a political crisis before the presidential election next spring," Mujtaba Rahman, managing director for Europe at Eurasia Group, said in a note on Monday.

Measures such as a partial freeze on pensions will be opposed by parliamentary factions, Rahman said, but Lecornu is likely determined to end the probable last months of his premiership "by forcing through a budget that will, in theory at least, begin the lengthy task of cleaning up France's state finances."

That could involve compromise on certain issues in talks with rival parties in the coming weeks, or once again resorting to special constitutional powers to pass a budget by the mid-December deadline, Rahman added.

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'Time is not in favor' of French bonds

The government's effort to get the budget deficit back toward 5% from an expected 5.4% this year will face "strong political headwinds," ING rates strategists Benjamin Schroeder and Michiel Tukker wrote in a Monday note.

"But even beyond that, we argue that time is not in favour of French bond spreads. After this year's budget, the focus will turn to the presidential elections. Those are likely followed by legislative elections and another potentially difficult government formation process," they said.

President Emmanuel Macron has installed a series of unpopular centrist loyalists as prime minister across his nine years in power. Next year's presidential election could deliver a shock from the political extremes, blowing open the question of leadership in the National Assembly once again.

Compounded by unfavorable conditions amid high European energy costs and fracturing European Union solidarity, ING strategists forecast the so-called "OAT-Bund spread" between French and German borrowing costs will sit between 100 and 125 basis points in the coming months. The European Central Bank may be unwilling to step in to reduce that spread with bond purchases while it is focused on fresh inflationary pressures, they added.

Chris Attfield, European rates strategist at HSBC, said the move in the OAT-Bund spread had been "far larger than we would expect" given France's debt-to-GDP ratio, but he added that the ECB would likely only intervene if market moves became "disorderly."

"One complicating factor is the rise in non-domestic ownership of OATs, which now exceeds 50%. If these investors prove less 'sticky', the question arises of where the swing investors are that will increase their holdings to compensate – and more importantly, at what price," Attfield said in a Monday note.

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Speaking to CNBC's Karen Tso on Wednesday, Lars Machenil, chief financial officer at BNP Paribas, said it was important for lawmakers to work on reducing France's debt — but "they should take the time to have a budget that makes sense and have it pivot in the right way."

"I don't have a crystal ball, but what I see is that there is a willingness to get this over [the line]," he added, when asked if he thought the budget would be agreed and approved before deadlines expired.

"We'll see. But if you see the progress, if you see the timing, things are progressing well," Machenil said.