By Sara Rossi
LONDON (Reuters) -France’s 10-year government borrowing costs are now at the same levels as Italy’s, the latest sign that political paralysis in Paris is stoking concern about its ability to get its public finances under control.
Fitch ratings cut France’s rating last week, a move that came after opposition parties united to oust Francois Bayrou as prime minister over his unpopular plans for budget tightening. President Emmanuel Macron then named Sebastien Lecornu as the country’s fifth prime minister in less than two years.
Italian and French 10-year bond yields both briefly traded at around 3.48% on Thursday, as the gap between the two narrowed to zero basis points (bps) from around 50 bps in April and as much as 200 bps during the 2020 Covid crisis, according to LSEG data.
WHAT’S THE BIG DEAL?
Investors now consider the creditworthiness of the eurozone’s second- and third-largest economies to be roughly the same. That’s never happened before.
It shows how far perceptions around France, once considered a “core” market, and Italy, long-regarded as one of the weakest links in the euro area, have changed.
In a sign of market confidence in Italy, foreign investors’ net purchases of Italian government bonds rose in June by the largest amount seen in any month since June 2019, Italian central bank data shows.
Foreign investors’ holdings of Italian debt stood at around 32% in May, still well below the 55% of French debt in foreign hands as of end-March, most recent central bank data shows.
WHY IS THIS HAPPENING?
Concerns that political instability will hamper France’s ability to improve its fiscal position have pushed up its bond yields. Meanwhile, relative political stability and downward debt projections, albeit from high levels, have pushed down Italy’s bond yields.
France’s Lecornu is racing to draft a budget that is due to be sent to lawmakers by October 7. Analysts say the uncertainty hampers the management of public finances.
France is under EU disciplinary measures with its 2026 deficit target at 4.6% of gross domestic product. Italy is expected to soon leave that procedure as it is close to bringing its budget shortfall to 3% of GDP.
WHAT DO THE RATINGS AGENCIES SAY?
Well, Fitch has just downgraded France’s sovereign credit score to the country’s lowest level on record, stripping the euro zone’s second-largest economy of its AA- status.
But Italy is likely to get a ratings boost when Fitch reviews the sovereign on Friday, analysts say.
A more positive outlook for Italy has helped push the premium that investors demand to hold Italian bonds over safer Germany to below 100 bps.
DOES THIS MEAN WE SHOULDN’T WORRY ABOUT ITALY?
No, and concerns around Italian debt are unlikely to disappear.
Italy has been plagued by chronic problems that will take time to fix. Italy still has the euro zone’s second-largest debt as a percentage of GDP after Greece, and well above France’s.
A falling population and a low female employment rate hinder its growth outlook. Italy’s statistics agency said in June that the economy would grow by 0.6% this year, trimming a previous forecast of 0.8%.
For some observers, the narrowing of the French-Italian bond spread has more to do with French fiscal and political woes than an improvement in Italy’s outlook.
Spanish, Greek and Portuguese bonds already pay lower yields than France.
WHAT’S NEXT?
After the collapse of the Bayrou government, analysts say France’s debt will remain under pressure compared with Italian paper. This trend may intensify soon following ratings agency reviews of both countries.
S&P has also cut the French ratings outlook due to a weakening of public finances while Moody’s downgraded its rating last year. Both review France in the months ahead.
(Reporting by Sara Rossi, additional reporting by Valentina Consiglio, editing by Dhara Ranasinghe and Gareth Jones)
