Source: CNN

French markets and the euro were roiled Monday by President Emmanuel Macron’s surprise decision to call a snap election after his party lost to the far right in a vote for European lawmakers.

Big gains for the far right in the French election could force Macron to govern with a hostile parliament, making it harder for his centrist administration to pursue its policy agenda and raising doubts about its ability to put government finances on a more sustainable footing.

France’s CAC 40 index, which represents 40 of the biggest companies listed in Paris, fell 1.8% by 11.02 a.m. ET, with banks among the biggest losers. Europe’s benchmark Stoxx 600 index was trading 0.5% down on the day by the same time.

The euro fell 0.6% against the US dollar in late-afternoon trade, sinking to its lowest level in a month. Against the British pound, the currency, shared by 20 countries in Europe, also dropped 0.6% to stand at its weakest level in nearly two years.

Macron dissolved the French parliament and called the election after an exit poll Sunday showed that his Renaissance party was set to be trounced by the National Rally, a far-right opposition party, in the European elections. The first round of the French election is scheduled for June 30, followed by a second round on July 7.

Under the French system, parliamentary elections are held to elect the 577 members of the lower house, the National Assembly. A separate election is held to choose the country’s president, and this is not scheduled until 2027.

Banks slump

That sets up the possibility of significant changes in the composition of the National Assembly, which could make it harder for Macron to govern.

“There’s an awful lot of moving parts, and it’s not clear what a (new) government would look like,” said Mike O’Sullivan, chief economist at Moonfare, a private equity investment firm. “Even if the (far right) don’t do very well, (Macron) would still have a varied coalition of the center (parties) to put together, and it’s not clear what key policies would unite those parties in a government.”

The uncertainty is rattling markets, he told CNN.

In his view, Macron and his government have been good for parts of the French economy. “For example, unemployment is at a historic low, parts of the economy — particularly the tech investment part — have been thriving… A lot of that becomes very uncertain.”

Shares in Société Générale had tumbled 8% by late afternoon in Paris, while shares in BNP Paribas and Credit Agricole were down 5.5% and 4.4% respectively.

Commenting on the losses suffered by French banking stocks, Johann Scholtz, an equity analyst at Morningstar, said investors were concerned about the National Rally’s “interventionist economic policies.”

“In many European jurisdictions, banks have become a soft target for populist measures such as windfall taxes and restrictions on dividends (and) share buybacks,” he wrote in a note.

Bond market jitters

Of particular concern, according to analysts, is how a potentially very different parliament would affect France’s ability to whittle down its huge government debt burden, which stood at 110.6% of gross domestic product at the end of last year.

The budget deficit — the difference between what the government spends and what it receives in taxes — reached 5.5% of the country’s GDP last year.

In May, ratings agency S&P downgraded France’s long-term credit score, citing the “deterioration of (its) budgetary position,” though it still thinks the country has ample capacity to repay its debts. The agency said it expected the budget deficit to narrow to 3.5% of GDP in 2027, which is well above the 2.9% targeted by the government for that year.

Andrew Kenningham, chief Europe economist at consultancy Capital Economics, wrote in a note Monday: “The immediate concern for the economy is that (a new parliament) could make it even more difficult for the government to bring down the fiscal deficit.”

Bond traders are taking notice. The yield, or interest rate, on France’s benchmark government bonds ticked up Monday to reach its highest level since late November. Higher yields indicate that investors want a bigger premium to buy French bonds given the political uncertainty.

The gap between yields on 10-year German and French government bonds also widened. In general, a larger gap or “spread” between the yields on a European country’s bonds and their ultra-safe German equivalents signals a higher risk for investors in holding the former bonds.

“A right-wing majority in the (French parliament) would hamper any reform plans. The deficit picture in France is already weak and this would further add to market concerns,” Mohit Kumar, chief Europe economist at Jefferies, an investment bank, wrote in a note.

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