Vive la différence: how do the UK and French bond market challenges compare?

Paul Diggle

Hello and welcome to Macro Bytes, the economics and politics podcast from Aberdeen. My name is Paul Diggle.

Lizzy Galbraith

And I'm Lizzy Galbraith.

Paul Diggle

So the UK has just had its budget. France is trying to pass one, and we are going to do a bit of a compare and contrast on French and UK fiscal policy, politics and the economy more generally. France has a seismic presidential election next spring. The UK government can't quite put paid to persistent speculation that it could have a snap election at some point. And both have been the focus of bond market pressures at various points this year. The gilt market was under particular scrutiny back in May earlier in the energy price shock and as the local elections are one of the final nails in the coffin of the former Starmer government. And French OAT yields have been under substantial pressure in October, again as the energy shock has been mounting once again and there has been a political driver in Marine Le Pen's rise in the polls and growing street protests in France. And on many of the headline fiscal numbers, the two economies look similar, 4 to 5% deficits, circa 5% 10-year bond yields, fairly low GDP growth, above 100% debt to GDP ratios, populations that can be quite resistant to spending cuts. But as we'll get into, there are also some important differences between the two economies in their fiscal arithmetic in the institutional context around fiscal policy in the two countries' respective politics. So all that matters for how we think about the economy, politics, the market outlook from here, that's what we're going to get into on this episode. Lizzy and I are delighted to be joined by Felix Feather, economist at Aberdeen for this episode. Welcome, Felix.

Felix Feather

Hi, Paul. Thanks for having me.

Paul Diggle

So Felix, let's get right into it. Tell us a bit about the pressures that have been ongoing in French bond markets of late. What has the market been worrying about and how has that been playing out in the price action?

Felix Feather

So the facts on the ground are that as of today, the 3rd of November, we're seeing this 10-year OAT yield, the primary benchmark of the interest rate faced by the French government at 4.94%. Importantly, that's 161 basis points higher than the yield on the equivalent German asset, the 10-year bund. That spread is now at levels last seen during the euro crisis, which makes for some pretty alarming headlines. And it really is striking how quickly this gap has opened up. It more than doubled over the past three months. Now the trigger for the sell off was undoubtedly politics. At the same time, France is going through a fraught budget process and disorderly protests on the streets, all while the major risk of next spring's presidential election is looming. I think that the roots of this sell-off actually go a little bit deeper than this. It was a while ago now, Paul, but you probably remember a couple years ago I was on this podcast talking about precisely this issue, and we will end up talking about a lot of the same things today. Persistently high debt piles, persistently wide deficits, a politics that seems unable to deliver the kind of consolidation that markets think that France needs. And we argued that day that tight spreads to bonds could no longer be justified and we now had to think of France more as a periphery market than a core one within the Eurozone context. For a long time, markets seemed content to price that as a slow burn issue. We saw the spreads of bunds soar to around between 55 to 85 basis points. But all the while the pressure was building under the surface. And I think what we've seen over the past few months is markets finally beginning to crack under the weight of that structural pressure, triggering a wave of selling. That doesn't mean that we are back in a euro crisis sort of world or anything of the sort. But the move does now have some of the characteristics that you worry about. Crowded positions have been unwound. Market liquidity has at points looked a little bit weaker. And French sovereign CDS spreads have moved markedly wider. And perhaps most concerningly, we're now seeing some signs of contagion into other Eurozone sovereigns, something that policymakers at the ECB will be paying plenty of attention to.

Paul Diggle

I remember that appearance on the podcast a few years ago, Felix, remember it well. You'd just written an excellent note for Aberdeen's clients called ‘France more periphery than core’. And I think indeed that's probably what the podcast episode was called if people want to go back and listen to it. And a lot of your analysis then about France's deep-seated fiscal challenges is indeed what's starting to now play out in the prices. But let's revise then some of what we talked about then. And why don't you talk us through the debt arithmetic, the settings of fiscal policy, some of the key ratios, debt to GDP and so on that matter, both for France and the UK?

Felix Feather

Well, I'm glad you set up the contrast with the UK there because it really is quite revealing. Narratives can sometimes obscure the hard facts in markets and it's been very easy to spin a negative narrative about OATs and their sharp sell-off over the past few months and I suppose I've indulged in some of that myself here. But it's true that the 10-year gilt yield is actually still slightly higher than the 10-year OAT yield. The recent UK budget went down without too much fuss with markets, but that remains the case. Now that's only true in a technical sense, however, which I'll come to because it's not necessarily a straightforward task to compare yields across different countries. But what we can compare is the fiscal headlines. And just as France's fiscal headlines look pretty stretched, so do the UK's. The UK's debt GDP ratio of 102% is a touch lower than France's 115%. And the UK actually had a wider deficit GDP ratio than France in 2025. It had 5.3%, France just 5.1. That said, this time I do think the narrative gives us a better sense of what's going on than the headline numbers for a few reasons. So one is that the UK is at least making some progress towards fiscal consolidation. The IMF has the UK deficit falling from 5.3% to 1.4% by 2031, whereas France only gets to 3.9%. And on net debt, it's a similar story. IMF sees France rising from 108 to 116%. The UK edging down from 94% to 92%. I'm sceptical of both of these sets of forecasts for a few reasons, but even a sceptic would have to concede that on the issue of deficit reduction, France looks materially worse placed than the UK. Two is a more prosaic but equally important point about how we compare yields across different countries, different economies need different prevailing interest rates over the long run. For example, the UK's appetite for importing goods makes it a candidate for high interest rates, whereas the Eurozone, which has consistently produced a savings glut since the Euro crisis, it only needs lower interest rates to contain inflation. So it's actually striking that one of France's key interest rates is comparable to the UK's at all. And actually, if we look at these yields on a hedged basis, which we probably should, France's five-year yield is over a percentage point higher than the UK's. Three, and most importantly, France is in a currency union, it doesn't have its own printing press. The UK borrows in its own currency and it has its own central bank, which can step in as a buyer of last resort as the BOE did back in 2022. But France borrows in euros that it cannot create. So in extreme scenarios, it can be more exposed to a sharp sell off.

Paul Diggle

Yeah, we'll get into some of those deep institutional differences because it does matter a lot that France is inside the Eurozone for how you think about questions of fiscal sustainability and crisis management. But one of the differences in the conjuncture at the moment, Felix, is the growth outlook, which has actually being brightening a little bit in the UK and meanwhile worsening a bit in France. And of course, that in turn plays into questions of fiscal sustainability. So why has the UK growth outlook got a bit better? Why has France got a bit worse?

Felix Feather

It's interesting. The UK outlook has been on a bit of a journey over this year. We were initially expecting around trend growth and then as the energy shock hit in the aftermath of the Iran war kicking off, most forecasters, including ourselves, revised those expectations down to expect the UK to deliver a slower rate of growth over 2026. But it's proven much more resilient than we've expected, especially on the investment side. Recently, we've upgraded our UK growth forecast from 1.3 to 1.5% this year. Now, we still expect a little bit of hurt to come in 2027 as higher interest rates and the real income shock imparted by higher energy prices feeds through to worse performance, but still this represents an upside surprise to where we were a few months ago. In France, the story's a little bit different. We haven't seen quite as much resilience, quite as much strength in investment there as we have in the UK and indeed the latest GDP figures showed a contraction with the headwinds compounding from high interest rates and subdued consumer confidence. The risk of recession seems to be growing and that's something that we can't rule out this winter.

Paul Diggle

Do the protests themselves have a dampening effect on growth? How should we think about the impact of extremists looting and so on, on activity.

Felix Feather

In extremis, it can have an impact. And I've seen estimates of the impact of the Gilet Jaune protests on GDP that were material, but only as high as a couple of tenths or so. And I don't think we're there yet. The hit to France's growth prospects that arises from any kind of political disruption is coming through higher interest rates. It's coming through uncertainty and it's coming through poor sentiment rather than physical disruption per se.

Paul Diggle

So Lizzy, let's talk about the fiscal architecture, the Office of Budget Responsibility, OBR in the UK in the fiscal rules. And then in the EU context we have another set of fiscal rules, we have things like the excessive deficit procedure. So starting with the UK then does the OBR and the fiscal rules add credibility to UK fiscal policy in the minds of investors? Or is it possible to game those rules?

Lizzy Galbraith

So at the risk of giving a very, very economist’s answer, I think both are slightly true in this case. Yes, we have seen many instances where the OBR and indeed we have complained that successive governments are slightly gaming the fiscal rules and indeed fiscal rules themselves have changed a fair bit from government to government since they were introduced in their sort of modern iteration in 1997 by the Blair government. We've actually had about 10 sets or so of fiscal rules since then. So governments do change them as and when they look like they might be getting harder to hit. And we've not really seen the presence of fiscal rules really mean that we've had a sustained reduction in the UK's deficit over time. So the extent to which the fiscal rules have necessarily been a success I think is questionable. However, what they do is they give markets confidence that you're not going to see a radical shift in the fiscal policy and the planned fiscal trajectory in a short period of time. And I think we can say in that degree, yes, they do give markets some level of confidence because in the UK's instance, we have quite a good example of what happens when markets don't have confidence that they're being upheld and that was the Truss mini budget where you didn't have the OBR being involved in that process. You didn't have market confidence that fiscal rules were being upheld and the response was quite sharp, quite significant and of course was rolled back and the Truss administration did not last particularly long after that. So I think there is an extent to which they are a confidence building measure and they do matter. We of course had market moves last year when then future Prime Minister Andy Burnham suggested that he wasn't necessarily as interested in upholding the current fiscal rules. That has since changed and as Felix said the most recent budgets was one where the fiscal rules were upheld and markets responded in a relatively benign fashion. So I think we can sort of prove the rule in instances where the absence of fiscal rules is the kind of the dominant narrative in markets. But have the goals of the fiscal rules been met? No, I think they have largely not been by successive governments.

Paul Diggle

A continual rise in debt to GDP ratios and the fact the deficit is quite large, I guess, is prima facie evidence of that. I do also like the rather dry way in which the OBR in its reports points out some of the assumptions it's forced to make, such as future increases in fuel duty, but it basically knows will not actually be carried out in actuality. Felix, the EU of course does also have its own set of fiscal rules and they apply the excessive deficit procedure when countries breach these fiscal rules as France is currently doing, running a deficit greater than 3% of GDP that the EU wants countries to meet. Does that constrain fiscal policy and politicians in Europe at all?

Felix Feather

You could give the answer that the fact that we're here and we're having this discussion about a potential French debt crisis as proving that no they have not worked, that might be a little disingenuous though. It's certainly true that France is bound by the terms of its EDP to reduce its deficit year on year and in theory it has promised to do so and the 2027 budget that was initially proposed but hasn't yet gone through the National Assembly did propose some consolidating measures, particularly when you compare that against a no policy budget, which would have pushed the deficit up even further to 6% of GDP. I think the more important disciplining function is not the rules themselves, but rather the markets. And this is what politicians will eventually respond to if France is to go down a different course. You maybe saw some preliminary evidence of that starting to happen when the OAT bonds spread peaked up in the 170s earlier in the past couple of months. That prompted the current presidential front runner, Marine Le Pen, to propose a golden rule for reducing the deficit year on year, which would be constitutionally binding. And that shows to me that fiscal pressures are starting to have some cut through with politicians, even if it is just at the margin and a lot of their plans remain not credible. Going forward, there's going to be a lot of pressure on the ECB to step in to alleviate some of the pressure on these French assets. But I think it is likely to resist the pressure to do that for the minute. And that will leave the onus very much on French politicians to change course if they are to ease some of the pressure in markets.

Paul Diggle

Let's talk about the possibility of French politicians and indeed UK politicians changing course or not. Lizzy is the French electorate, French political system resistant to the sort of fiscal changes that might be required to bring about fiscal consolidation? Obviously, one thinks most systemically in France about increases to the pension age, but similar issues in the UK as well. How should we think about political willingness or unwillingness to actually make some of those changes that markets seem to be at points demanding?

Lizzy Galbraith

You definitely do have a more ingrained culture in France of sort of popular protest where voters disagree with direction of travel in the government. So I think it is more easily put in the front of mind of investors where there is a divergence between popular opinion and government reforms. But I also think that in the French case, some of these measures weren't necessarily sold to the public in advance. They were sort of pushed through. So there was I think maybe a difference in the way that we're getting the early stages of the UK's attempt at pension reform. Prime Minister Andy Burnham has sort of said that he's going to put a reform of the triple lock into his next manifesto and we'll I think get on to whether or not that may be coming slightly earlier than planned in the UK. But there's kind of early steps emerging about gaining a consensus around pension reform in the UK and of course President Macron did run on a similar mandate during his second presidential run. However, the difference between France and the UK I think on this issue is that you have a more openly divided electorate in France. The parliament is split more evenly between parties of a lot of different stripes and indeed France currently operates a minority government. And that is quite a difficult environment through which to sort of find consensus and it's created quite an adversarial atmosphere in French politics. The UK currently does not have that same issue and the current Labour government has a very large majority. So I think there's differences in how political pressures are currently manifesting. Were we to get to the point of a pension reform proposal being introduced in the UK, I don't doubt that it would still be a relatively controversial measure that would certainly divide the electorate. Would it be likely to trigger protests in the same way that we saw in France? I don't think that would be how voters in the UK would necessarily show their displeasure. But we of course do still have plenty of instances in the UK where the government has made decisions that are not necessarily ones that make a whole lot of fiscal sense to avoid picking fights with the electorate. You mentioned the kind of the constant rolling over of fuel duty at budgets. That's a big one. Triple lock itself is another one that was supposed to be a temporary measure and it's become so popular with a certain very influential slice of the electorate that governments have just kept it rolling now for over a decade. So I think in both cases you do have an electorate that does have quite strong views about certain policies and would like to see them upheld. What we're now starting to see though is that there's quite a big generational divide between slices of the electorate in both countries pushing for reform and arguing that the current system benefits a certain type of voter, a certain age of voter, and those who benefit from the current status quo that don't want to see the current policies withdrawn.

Paul Diggle

So we've been circling around a little bit in this conversation around Marine Le Pen, leader of Rassemblement National, odds on favourite in betting markets and political prediction markets to win the French presidential election next May. Lizzy, tell us a little bit about what she might mean from a fiscal policy perspective, because some of the run-up in French spreads that Felix has been talking about over recent months seem to track a particularly strong period for her in opinion polling. But clearly, as we've been saying, it's not just that, it's about deep-seated structural issues to do with French fiscal policy. So what would she mean from a fiscal policy perspective? Is she a populist spender or Felix highlighted her proposing golden rules to rein in fiscal spending.

Lizzy Galbraith

So Marine Le Pen has obviously been in and around French politics now for quite a long time and has run for president before and certainly in previous presidential runs and up until quite recently I think yes you probably would have described her fiscal policy as being fairly populist. She's strongly against Macron's pension reforms. She said she would reverse those. She's in favour of relatively high welfare spending for those born in France. She's in favour of cutting benefits for immigrants and she's in favour of reducing payments to the EU. Now the trouble is that, as Felix alluded to, some of these measures don't really add up, particularly when you start trying to say that you're going to uphold or even tighten the French fiscal rules and deficit reduction targets. Maintaining the current French pension system is a very significant outlay. It's definitely questionable as to whether or not France could in fact reduce its payments to the EU without triggering a serious confrontation with the European Commission and likewise maintaining the current benefit system for a large slice of the current French population would also be very expensive. So I think there are still concerns around Le Pen's fiscal instincts, particularly given that a lot of her most ardent supporters have come to assume that those are the policies that she'll stick to, that she's known for. So there probably is a decent amount of pressure on her to keep that slice of the electorate happy. But as Felix mentions, she has in the last few months given some signs that her polling, which is very strong, combined with the market concerns are leading her to sort of moderate her position a little bit. She's proposed a referendum if she's elected on the introduction of new binding fiscal rules that the French government would be governed by. But as I said, really not entirely clear as of yet how she intends to mesh her own party's policy platform with those proposed fiscal rules if we actually get to that point.

Paul Diggle

So I want to briefly mention Christine Lagarde, the president of the European Central Bank, who resigned just before the most recent ECB meeting. And she has at times been linked to wanting a role in French politics, perhaps a little bit of speculation that she's left the presidency of the ECB early to make some sort of run as some sort of unity candidate. Do you think that's plausible, Lizzy?

Lizzy Galbraith

Whether she wants to run or not, she's facing a very, very crowded field of aspiring unity candidates in the French political system right now. So I think she would certainly face quite an uphill battle if that's part of the plan for how she wants to spend the next few years. We are seeing quite crowded fields in the French presidential election so far. A lot of candidates trying to occupy the space between Marine Le Pen on the right and Jean-Luc Melachon on the left. Really, you'd be wanting to sort of see some consolidation there. And she's been out of direct French politics now for quite some time. Not entirely clear to me where her base instinctually lies, whether she can carve out a space for herself within that current field. And I think it is worth noting that because you have such a of a wide variety of candidates occupying that middle ground or extended middle ground right now. In the absence of consolidation in that field, we are kind of leaving the door open to a candidate outside the centre getting through to the second round alongside Le Pen who remains sort of head and shoulders above the rest of the fields and everyone else is sort of crowded around in sort of the high teens in current polling averages. So she may well do. It's certainly possible. I don't think she's ruled it out, but she would face quite a significant challenge in being successful in that endeavour. And I think we would be looking to see that field consolidate if we were to see some of the risks around the French presidential election next year reduce over the next few months.

Paul Diggle

Let me ask a question then about the possibility of a snap election in the UK, because this is sort of the speculation that just won't go away. And one of the possible readings of the recent UK budget, which was a pretty small affair actually in the end, pretty limited giveaways or tax increases, reduction in the fiscal headroom against the rules, almost a non-event in financial markets, but a lot of difficult decisions perhaps punted to 2027 when there'll be increases in defence spending, difficult questions about departmental spending will have to be answered. And people have suggested, well, that means there could be a snap election to loosen Labour's manifesto commitments around not increasing the major taxes to then give the government more fiscal room. What do you think, Lizzy, likely or not?

Lizzy Galbraith

I think it's definitely possible, but I think it is still very, very dependent on how polling for the government looks after the winter and it could well be quite a difficult winter. We're looking at energy bills in the UK rising quite substantially. We're potentially looking at that putting further pressure on the cost of living. That's not necessarily a good environment for any government to be calling a snap election even if Andy Burnham does put faith in his powers of persuasion and his ability to bring back the 2024 Labour coalition, which has fractured somewhat between different parties. So I think the government is certainly keeping its options open there. And as you said, it has kicked a lot of big decisions on spending to next year. It's not entirely clear how it plans on funding all of those decisions as of right now. And it is definitely true that the 2024 Labour manifesto does constrain the government on its revenue raising options. That manifesto rules out any changes to income tax, corporation tax, employee national insurance and VAT, all of which are essentially the major revenue raisers available to the government and that is one of the reasons why we have seen so many small measures at recent Labour government budgets, some of which have had quite distortive measures. So it would give the government more flexibility if they didn't have to abide by those manifesto commitments anymore. Andy Burnham has of course talked up this 10-year plan he has and made clear that he has these big aspirations on things like pension reform, social care, defence spending, as you said, that don't necessarily align with the time he has left in this parliamentary term, certainly the fiscal profile. So I think the government is keeping its options open. I think if the polling looks relatively positive in going into spring next year, the government will be tempted to do so. And I think they would be willing to trade a smaller majority for more flexibility. So I don't think maintaining the current very, very large Labour majority is necessarily going to be a goal. Obviously keeping a majority would be, however, so polling dependent, but very much possible.

Paul Diggle

Okay, Felix, a last question to you then. We were, of course, earlier talking about the institutional context, in particular the importance of the fact that France is inside the Eurozone, it does not borrow in its own currency, it does not issue its own currency, it does not have monetary sovereignty and effectively doesn't have its own central bank. And that matters in extreme circumstances. It can't depreciate its way to increase competitiveness and a lower nominal debt load. It does not have this theoretical ultimate backstop of monetary financing. But in response to those sort of institutional constraints and lessons learned during the euro crisis, the ECB has this toolkit of tools, outright monetary transactions, OMTs, which were Draghi’s ‘whatever it takes’ tool to buy government debt, support debt markets that way. The Transmission Protection Instrument, the TPI, Lagarde's tool to effectively close spreads and to avoid fragmentation between the Eurozone economies. At what point do those sort of tools become a serious consideration for the ECB amid stress in French and perhaps other sovereign debt markets?

Felix Feather

Yeah, so I think you're right to call out that there's a number of things that the ECB could do. But the most important one, the real game changer, I think is the TPI, which you referenced there, the transmission protection instrument. That would allow the ECB to make unlimited purchases of French debt if it needed to. It was introduced back in 2022 when we saw a somewhat similar sell off in Italian sovereign debt. But it would be very controversial to implement and actually it's never been deployed in its history so far. It would be so controversial because we would be using the ECB's balance sheet to buy up one country's debt and therefore mutualise the risk of holding that debt across the entire euro system. If France's debt were to suffer more mark-to-market losses or to in extremis, go through a restructure of some sort, well then it would be the entire euro system that would bear at least a portion of those losses, they would be remitted to national central banks. And ultimately, if you follow this logic through to its natural conclusion, taxpayers in all the euro area countries would be on the hook for them. So it has its critics and that means the bar to an intervention is going to have to be set very high. I don't think we're there just yet. At a bare minimum, I think you need to see spreads move higher from here. So reminder they're currently at 161 basis points at time of speaking. I think you need to see them in the 200 to 250 basis points before TPI intervention becomes a serious possibility. In the ECB's own language, you also need the spread widening to be unwarranted, disorderly and a threat to monetary policy transmission. So wider spreads isn't enough on its own. You would need contagion into countries with better fundamentals. We've seen a little bit of that so far, but not very much. Rapidly widening CDS spreads, again, we've seen this start to kick off, but not so much so far. Severe pressure on French banks might also be a waymark to ECB intervention because that is the exact sort of thing which you would think about as compromising transmission of monetary policy. And you need to see a clearer steer from the ECB as to what these waymarks are, because it's going to try and use rhetoric to step in before it actually deploys the mechanism, because I think it would rather leave its powder dry, if at all possible. And there are probably other rungs of the ladder we need to climb before the ECB seriously thinks about deploying TPI. It can take standard policy in a different direction if it feels that financial conditions have tightened a lot more than they would have done. It might argue that less monetary tightening is needed and therefore the hiking cycle, which we're currently in, might be curtailed shortly. Or we could see a change to the reinvestments of prior balance sheet expansion, government bonds that are already on the ECB's balance sheet could be reinvested once those expire and that might ease pressure on the broader periphery and France in particular. Those tools are less contentious. I suspect the ECB would draw from them first, but it's possible that TPI does crystallise at this point. We are moving towards those margins where we need to take that risk more seriously. And that all raises the stakes for the next ECB appointment. We don't know if Christine Lagarde is going to be the next president of France, but we do know that there's going to be another president of the ECB pretty shortly, and we don't know who that person is going to be. We do know that there are a lot of different views among the monetary policy officials of different countries across the Eurozone. If we do get somebody who's very sceptical of expansive balance sheet policy, that could place further pressure on OATs as investors grapple with the idea that the ECB is now led by somebody who is really opposed to using these tools at all costs. The flipside of that is if we do get a more dovish leader of the ECB, probably from another periphery or southern European nation, well, that could mean that there's some potential for OATs to rally into the prospect of lower waymarks to ECB intervention using the TPI or any other mechanism for that matter.

Paul Diggle

Great. Well, that is about all we have time forbthis week. Thank you, Felix, for joining myself and Lizzy. Thank you to you for listening to Macro bytes as ever. Don't forget to like and subscribe on your podcast platform of choice. But until next time, goodbye and good luck out there.

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