France's bond risk premium hits 2012 high as budget worries mount

France's cost of borrowing relative to Germany climbed past a full percentage point on Friday, the first time since the euro zone debt crisis, as investors demanded greater compensation for holding the country's debt amid mounting budget concerns.

The premium on French 10-year bonds over German bunds reached 104 basis points, a level last seen in 2012. The spread has doubled since a snap election in 2024 produced a fractured parliament, making it harder to rein in a budget deficit that ranks among the euro zone's largest.

Deficit reduction under pressure

The government aims to bring the deficit down from 5.4% of output this year to 5% next year through €54 billion in spending cuts. Opposition parties are expected to challenge those measures in the coming months, potentially toppling the government. Lower-than-expected growth means this year's original 5% target will be missed, and rising energy prices linked to the Middle East conflict — which have led investors to bet on further European Central Bank rate hikes — could weigh on growth further.

Concern is also building that next year's presidential election could derail deficit reduction. The far-right's Marine Le Pen and the far-left's Jean-Luc Melenchon are the frontrunners. Melenchon's call for the French central bank to cancel the government debt it holds has unsettled investors, while Le Pen, who leads the polls, advocates lowering the retirement age for some people, adding pressure on the public finances.

Italy's bond spread has also widened, but by much less than France's 40 basis-point rise since June.

Rising debt-servicing costs

A wider spread makes new borrowing more expensive and adds to debt-servicing costs, already France's biggest budget expense as it refinances hundreds of billions of euros of COVID-era debt taken on at ultra-low rates. The government expects debt-servicing costs to be €4.5 billion more than anticipated this year because of higher interest rates, and a further €10 billion higher next year. Economists worry that with low growth and rising rates, France faces a snowball effect in which borrowing costs spiral unless it posts a primary surplus — something it is far from achieving.

A safe asset losing its shine

The development is particularly telling because France's bond market, the euro zone's largest and traditionally viewed as relatively safe, is losing that status. The last time France paid a three-digit premium over Germany was in 2012, when the future of the euro was in question. France is now paying a higher premium than Italy, a country with more debt and lower credit ratings. Many investors say they are reluctant to favour French bonds in their portfolios.

Paying a 100 basis-point spread over Germany shows "France has real problems, and that they're not going to be solved anytime soon," said David Zahn, head of European fixed income at Franklin Templeton.

How much further?

Given the scale of the move, some analysts see limited scope for a significant rise in the near term. "At some point, unless you think they're on a road to something really horrible, you've got to make the judgement that there's enough compensation for taking on the sovereign risk," said L&G's head of macro strategy Chris Jeffery, who recently closed a position betting against French bonds.

Further political uncertainty could still push the spread wider, analysts say — for instance if the government falls and leaves France without a budget, or if Melenchon and Le Pen meet in the second round of the presidential election. Societe Generale has not ruled out a move to 120 basis points.