ECB holds rates as France struggles with debt crisis

Fast reading

French prime minister Francois Bayrou resigned this week after the National Assembly rejected his austerity budget in a no confidence vote
ECB president Christine Lagarde expressed confidence that policymakers in member states would want to reduce uncertainty, as the central bank elected to hold interest rates steady at 2%.
Elsewhere, Indonesia’s finance minister Siri Mulyani Indrawati was abruptly sacked on Monday in a move that will heighten uncertainty for investors.

The European Central Bank (ECB) held interest rates steady on Thursday, as the deepening crisis in the eurozone’s second-largest economy loomed large.

France’s government collapsed on Monday, leading to the loss of its third prime minister in just 12 months. Francois Bayrou resigned after the National Assembly rejected his austerity budget in a no confidence vote¹. President Emmanuel Macron appointed Sébastien Lecornu as the new prime minister on Wednesday².

Market reaction to the news was largely muted, and the benchmark CAC 40 index was up 1.3% over the course of the week³.

Amid widespread anti-government protests, Lecornu is faced with the same issue that brought down Bayrou after less than a year in the role – the poor state of France’s public finances.

France’s debt burden currently stands at around €3.3tn, representing 113.9% of GDP⁴. Debt is projected to rise to nearly 120% of GDP in 2026, according to the Organisation for Economic Co-operation and Development (OECD). The fiscal deficit was 5.8% of GDP in 2024, while the government is targeting a reduction to 5.4% in 2025⁵.

All of this means France is comfortably in breach of the European Commission’s agreed reference values of a 3% deficit ratio and a 60% debt ratio for member states⁶. The escalating crisis means that France may be on track to receive a downgrade to its credit rating, notes Mitch Reznick, Group Head of Fixed Income – London, Federated Hermes Limited.

“Reversing the widening government remains a meaningful challenge and for the sins of trying to do just that, Bayrou was shown the door. On Friday 12 September, the country could very well see its credit rating downgraded by Fitch. The bond market is taking this all in with a bit of fraîcheur… for now. The difference between the French 10-year bond and the German equivalent has been cuffed around 80 basis points, close to the wides it hit when the confidence vote was originally announced, he says.”

“Meanwhile, as we have said before, we struggle to see how French risk can rally meaningfully in the near-term, which may up some investment opportunities,” he adds.

The bond market is taking this all in with a bit of fraîcheur… for now.

Figure 1: Yield spread – the difference between French-German 10-year yields

The governing council of the ECB elected to hold interest rates steady at 2% on Thursday. At a press conference, ECB president Christine Lagarde declined to comment on France specifically but expressed confidence that policy makers in member states would want to reduce uncertainty and operate within the ECB’s fiscal framework⁷.

Indonesia changes course

Elsewhere, Indonesia is grappling with its own problems amid heightened economic uncertainty in Southeast Asia’s largest economy.

Finance minister Siri Mulyani Indrawati was abruptly sacked on Monday, following days of civic unrest, and was immediately replaced by economist Purbaya Yudhi Sadewa. The transition will likely heighten uncertainty for investors because of Indrawati’s longstanding role in shaping the country’s reputation for fiscal discipline.

“Indonesia’s strict fiscal posturing may have arguably limited its growth upside, and an increase in government spending may spur the creation of better paying middle class level jobs,” says Jason DeVito, Senior Portfolio Manager for Emerging Market Debt at Federated Hermes

“While we acknowledge the risks associated with staffing changes and a possible deviation from established proven policies, we also recognise the need for additional and more diverse economic growth. As such, we believe it’s too early to formalise a long- term view solely based on this week’s developments,” he adds.