French credit ratings in the spotlight

The French government fell yesterday when the French Assembly passed a motion of no confidence in Prime Minister Bayrou, killing his budget. The previous Prime Minister Michel Barnier, was toppled in December 2024, over his budget.

France has been unable to pass a budget for over a year. Yet market reaction to the latest developments was muted. Everyone is waiting for the verdicts of the credit ratings agencies. Here is the timetable:

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WHY are the credit ratings so important? The answer is to do with eurozone Banks and Pension Funds. They are forced buyers of euro-denominated government bonds to park their reserve capital.

The safest assets are triple A rated government bonds. In the eurozone, only Germany, the Netherlands and Luxembourg are AAA rated - but they arn't issuing many bonds. Instead they're running fairly tight budgets - though Germany recently lifted it's debt brake to accomodate defence spending. So investors have to settle for AA and AA- bonds. These are issued by France, Finland, Ireland and Austria. Of these, the French bond market is the biggest pool, as France is a big country and their govt is issuing plenty.

But what happens if the rating agencies downgrade French debt? These forced buyers will disappear and bond yields will rise.

President Macron then has the option of declaring a state of emergency and forcing a budget through by decree. If that doesn't calm the market the ECB will have to intervene, buying French debt in the secondary market with printed moey. But that has inflationary side effects.