End of France’s free ride sparks Eurozone stability fears

Sunset in Paris. Photo: CC0 via pxhere.

The collapse of Prime Minister Michel Barnier’s government has pushed France to a critical juncture, marking what some economists are calling “the end of the free ride” for a country long criticised for its fiscal indiscipline. Bond markets meanwhile embrace Denmark as a best practice example for the eurozone.

After just three months in office, Barnier’s administration on Wednesday evening fell to a no-confidence vote following a failed attempt to pass a 60-billion-euro budget aimed at tackling spiraling deficits. Anticipation of the collapse had already sent shockwaves through financial markets, with widening French bond spreads raising existential questions about the stability of the eurozone.

The spread between French government bonds and German bunds has reached levels not seen since the 2012 eurozone sovereign debt crisis, a stark indicator of investor unease. By late afternoon on Wednesday, yields on French 10-year government bonds (OATs) stood at 2.92 percent—84 basis points higher than equivalent German bunds, marking the widest gap in over a decade.

Barnier’s fall highlights both the fragility of France’s political system and the precarious state of its public finances. Economists warn that France’s fiscal and political instability is not just a national issue but a potential threat to the structural integrity of the eurozone.

Toxic dynamic

Raphaël Gallardo, chief economist at French asset manager Carmignac, offered a blunt assessment: “This marks the end of the free ride for France,” he said, emphasising that years of fiscal mismanagement have caught up with one of the eurozone’s largest economies. “France has been skating by on leniency, but the market is now pricing in the risks of its twin deficits and heavy reliance on foreign creditors.”

Gallardo pointed to the toxic dynamic between France’s growing public debt—55 percent of which is held by foreign creditors—and its membership in the eurozone. Unlike countries such as the United States, France cannot control its currency, as monetary policy is governed by the European Central Bank (ECB).

“Any adjustment to its fiscal imbalances will have to come through real variables like growth and austerity, not nominal variables like inflation or interest rates, which are largely out of its control,” Gallardo explained during a conference call ahead of Wednesday’s vote in Paris.

Political paralysis

France’s twin deficits—its fiscal deficit and current account deficit—make it especially vulnerable during times of political instability. Leo Barincou, senior economist at Oxford Economics, noted that the collapse of Barnier’s government is both a symptom and a cause of France’s structural challenges.

“The government’s inability to pass a budget reflects the difficulty of achieving fiscal consolidation without a parliamentary majority or cross-party consensus,” Barincou said. “Even before this crisis, we expected French bond spreads to remain elevated due to persistent deficits and political instability. Now, with Barnier’s fall, short-term volatility will increase, but the structural challenges remain unchanged.”

Gallardo added that the fallout goes beyond fiscal metrics. “This moment raises fundamental questions about the long-term viability of the common currency, especially when a core member state like France fails to enforce basic fiscal discipline.”

On par with Greece

Indeed, France’s bond yields now approach those of Greece during its debt crisis, underscoring its outlier status within the eurozone. “While other member states have made progress in stabilising their finances, France has continued to delay necessary reforms. The result is a deeply indebted country with limited room for manoeuvre,” Gallardo said.

Gallardo, meanwhile, warned of the potential long-term consequences for the common currency. “If France, a founding member of the eurozone, cannot resolve this crisis swiftly, it could lead to deeper questions about the viability of the currency union itself.”

Barincou echoed these concerns, pointing to broader implications for European governance. “The eurozone cannot afford a prolonged crisis in one of its core economies. It not only undermines market confidence but also risks eroding political cohesion within the bloc.”

Markets embrace Denmark as example for eurozone

Investors are increasingly sceptical of the eurozone’s ability to manage crises in core economies and have come to look at Denmark as a best practice example for Europe. Danish bond spreads recently turned negative relative to German bunds, reflecting market confidence in Denmark’s monetary independence and the potential for its currency, the krone, to appreciate.

“This contrast with France underscores the market’s scepticism about the eurozone’s resilience,” Gallardo said, referring to recent relative strength in Danish bonds.

Unlike eurozone countries, Denmark’s government finances are exceptionally strong, with reserves equivalent to several years’ worth of issuance held at the central bank, ensuring stability even in adverse scenarios. That position becomes clearer now that France is in trouble.

“The DGB-DBR spread has tightened a lot for sure, and France is part of the story,” Anders Svendsen, head of analysis at Nordea Markets, explains, referencing the narrowing gap between Danish government bonds (DGBs) and German bunds (DBRs) in a comment to Investment Officer.

Absence of QT

The French turmoil is only part of the Danish story. Denmark’s central bank avoided the quantitative easing (QE) measures adopted by the ECB, meaning there is no quantitative tightening (QT) in Denmark, while the ECB is withdrawing 40 billion euros per month. This absence of QT, combined with unchanged issuance levels for Danish bonds, has contributed to the positive performance of DGBs.

“DGBs reflect a healthy Danish economy,” Svendsen said, contrasting them with French OATs. While France’s struggles with fiscal and political instability dominate headlines, Denmark stands as an outlier, demonstrating the resilience of its financial system and the benefits of prudent fiscal management.