By Stefano Rebaudo and Samuel Indyk
(Reuters) -The risk premium investors demand to hold French debt rather than German bunds dropped on Thursday on optimism that France will be able to pass a budget, while German bunds fell on reports Europe plans to tap bond markets for a defence fund.
Far-right and left-wing lawmakers in France joined forces this week to back a no-confidence motion against Prime Minister Michel Barnier. He formally resigned on Thursday, deepening the political crisis in the euro zone’s second biggest economy.
Analysts fear the lack of a stable government and a budget for 2025 could lead to a deterioration of France’s sovereign creditworthiness and slower economic growth.
But markets were soothed on Thursday by comments from Marine Le Pen of the far-right National Rally (RN), which voted to oust Barnier, saying that she had no plans to seek the removal of President Emmanuel Macron and that a budget could be passed within weeks.
The spread between French and German 10-year yields, a measure of the risk premium investors require to hold French debt over German, tightened to 77.2 basis points (bps), its narrowest level in almost two weeks.
It had hit 90 bps on Monday, its widest since 2012.
“Le Pen’s comments clearly provide some reassurance that an agreement on the budget can be achieved ‘within weeks’ and this is a positive development from a market perspective,” said Emmanouil Karimalis, macro rates strategist at UBS.
Markets now await the next move from Macron, even if most analysts remain sceptical about a significant change in the current situation. Sources said he aimed to install a new prime minister swiftly.
Meanwhile, Germany’s borrowing costs rose after the Financial Times reported that countries in the European Union were discussing a 500 billion euro ($527 billion) joint fund for common defence projects, potentially tapping bond markets to boost spending.
Germany’s 10-year yield, the benchmark for the euro area, rose 6 bps to 2.124%. Bond yields move inversely with prices.
“Details are still very scarce on this fund but of course it needs more supply of bonds, so that could be in play in terms of bunds,” said Danske Bank analyst Rune Thyge Johansen, on the underperformance of German bunds.
“As I saw it, it shouldn’t directly be euro bonds but more that the countries will pool resources together, so a natural reaction is that a lot of that will come through German bunds. You have greater credit quality there,” Johansen added.
German bonds underperformed the debt of other countries, with the spread between German and Italian 10-year yields narrowing to 108 bps, its tightest level since January 2022.
($1 = 0.9474 euros)
(Reporting by Samuel Indyk and Stefano Rebaudo, additional reporting by Harry Rovertson; Editing by Toby Chopra, Alexandra Hudson and Gareth Jones)
