French stocks, bonds tumble as government faces potential collapse

French stocks, bonds tumble as government faces potential collapse

 Alun John and Dhara Ranasinghe

The prospect that France's minority government could collapse soon triggered a sharp selloff in French stocks and bonds on Tuesday, pushing political risks from the euro zone's second biggest economy back to the forefront of investors' minds.

Three main opposition parties said they would not back a confidence vote which Prime Minister Francois Bayrou announced for September 8 over his plans for sweeping budget cuts.

France's blue chip CAC40 index fell over 2% to its lowest level in almost three weeks, having fallen 1.6% late on Monday. Banking giants BNP Paribas and Societe Generale slid more than 6% each, while midcap stocks slid nearly 3%.

Meanwhile, 10-year French government bond yields briefly rose to 3.53%, the highest since March, before steadying at 3.50%. When a bond's yield rises, its price falls. 

The gap between French and German 10-year yields, a gauge of the premium investors require to hold French debt, widened to around 79 bps -- its largest since April. 

Analysts had anticipated a return in French political risk come autumn as the government tries to secure support for steps to improve France's fiscal position. 

But Monday's developments came as a surprise.

If Bayrou loses the confidence vote in the National Assembly, his government will fall. President Emmanuel Macron could then name a new prime minister, ask Bayrou to remain head of a caretaker government, or he could call a snap election.

"It looks like Bayrou will be gone. It will be hard for Macron to install another Prime Minister if a confidence vote is lost, without going to new Parliamentary elections," said Mark Dowding, chief investment officer for BlueBay fixed income. 

"This should weigh on French debt in the coming weeks on the risk that Le Pen's National Rally ends up winning a majority," said Dowding, adding that he anticipated a further widening in French bond spreads in the weeks ahead.

 Finance Minister Eric Lombard said on Tuesday he was "certainly not resigned" to the idea of Bayrou's minority government falling next month.

Lombard also suggested there was a risk the International Monetary Fund would have to intervene in the economy if France doesn't get its finances in order.

Latest developments are also a reminder that French turmoil could temper sentiment towards "Make Europe Great Again" trades, with European economies benefiting from U.S. policy uncertainty and steps to boost long-term growth prospects from heavyweight Germany.

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