French government bonds under pressure after Moody's downgrade

French debt is once again worrying investors, according to the widening interest rate spread between 10-year bonds of France and the eurozone benchmark, Germany.

France's borrowing costs surpassed 3.05% on Monday morning, as trading restarted for the first time after one of the biggest credit rating agencies Moody's downgraded the country in an unexpected move on Saturday.

France's new long-term issuer rating became Aa3, one step down from the previous Aa2 and the agency changed the country's outlook from negative to stable. This category aligns with the category France has already been given by the two other main rating agencies.

Moody's decided to downgrade France's debt because "the country's public finances will be substantially weakened over the coming years" as "political fragmentation is more likely to impede meaningful fiscal consolidation," the agency said in their statement.

Political turmoil in France

On Friday, French President Emmanuel Macron appointed the country's fourth Prime Minister this year. Centrist François Bayrou follows Michel Barnier on the post, who resigned after his belt-tightening budget earned him and his government a successful no-confidence vote from the National Assembly more than a week before.

The newly forming French government has an urgent task of ensuring that the country has a valid budget for the year ahead.

"We expect the newly-appointed government to push through a special law ensuring the continuity of the public administration in 2025," said Moody's in their statement.

The outgoing government had the difficult task of economic belt tightening, as France is grappling with a deficit that is expected to surpass 6% of the GDP in 2024 and a mounting debt, a record €3.228tn, amounting to 112% of GDP, well above the 60% limit set by EU rules.

The French Minister of Economy Antoine Armand reacted to the decision on X, saying that "Moody's has announced the change in France's rating to Aa3, highlighting recent parliamentary developments and the current uncertainty that results from them regarding the improvement of our public finances. I take note of this. The appointment of Prime Minister François Bayrou and the reaffirmed desire to reduce the deficit provide an explicit response."

The enormous task of putting the debt and deficit on a sustainable path is awaiting the incoming government. According to the credit rating agency: "Looking ahead, there is now a very low probability that the next government will sustainably reduce the size of fiscal deficits beyond next year."

As a result, Moody's expects that France's public finances will be weaker than previously expected for another three years.

The stark outlook sparked increased pressure on France's government bonds on Monday morning, pushing the 10-year borrowing costs beyond 3%, making it increasingly expensive for the country to finance its debt. The spread, between the 10-year bonds of the Eurozone benchmark Germany and France, widened to more than 80 basis points.

The elevated 10-year bond yields resulted in the debt servicing costs of France being higher (and judged riskier by investors) than those of Portugal, Slovenia or Croatia in the early afternoon trade on Monday.