When the European Central Bank's Governing Council convenes next Thursday, the headline decision is likely to be a hold on interest rates. But the real drama is unfolding in the bond markets, where France's borrowing costs have surged to levels not seen in over two decades, tightening financial conditions across the eurozone and putting the spotlight on Paris's fiscal paralysis.
The yield on France's 10-year government bond traded above 5% on Friday, after first breaching that threshold on Wednesday for the first time since 2002. The spread over German bunds, the eurozone's benchmark safe asset, widened to more than 170 basis points. The 30-year yield reached 5.5%, with the gap to its German equivalent even steeper at 184 basis points. On Thursday, the cost of insuring French sovereign debt against default—measured by five-year credit default swaps—climbed above 100 basis points for the first time since October 2012, during the depths of the eurozone debt crisis.
The sell-off reflects deep political uncertainty. Lawmakers remain deadlocked over next year's budget, which proposes €43 billion in spending cuts and additional revenue measures, but the government of Prime Minister Sébastien Lecornu lacks a parliamentary majority to push it through. Ratings agency Moody's, which currently rates France Aa3 with a negative outlook, is due to deliver its verdict on Friday evening. A one-notch downgrade to A1 would align Moody's with the assessments of S&P and Fitch, and is widely anticipated.
Bond markets doing the ECB's work
The case for another rate hike has not vanished. The ECB has raised its deposit rate twice this year, to 2.5%, and eurozone inflation jumped to 3.8% in September, driven by energy costs. Yet the sharp rise in long-term yields since September is already doing some of the central bank's tightening for it. Carsten Brzeski, global head of macro at Dutch bank ING, estimated in a note on Thursday that the increase in German yields alone has a macroeconomic effect roughly equivalent to a 25 basis point rate hike. "For France, it's closer to a 50 basis point hike," he wrote, adding that "the bond market has taken over the ECB's job." Brzeski expects the ECB to wait for new staff projections in December before deciding on its next move.
ECB President Christine Lagarde acknowledged the tightening effect in a speech to the European Parliament on 28 September, noting that long-term rates "have risen notably, which will slow growth." But she has repeatedly pushed back against expectations of central bank intervention to ease France's borrowing costs.
Speaking on the sidelines of the IMF and World Bank annual meetings in Bangkok last week, Lagarde said that "there are particular circumstances that lead to some countries being more affected, France being a case in point." She added: "The primary and first solution lies at home in France. And it has to do with fiscal policies."
Banque de France governor Emmanuel Moulin went further last Friday, stating that the conditions for ECB intervention were not met because there was no financial fragmentation in the eurozone. However, both officials spoke before France's 10-year yield crossed the 5% threshold.
Intervention tools and their limits
If the ECB were to intervene, its most likely instrument is the Transmission Protection Instrument (TPI), created in 2022 but never used. The TPI allows the central bank to buy the debt of countries whose borrowing costs rise in ways it deems unjustified by economic fundamentals and that threaten the transmission of monetary policy across the eurozone. Eligibility requires countries to comply with EU fiscal rules and keep debt on a sustainable path—a condition France currently struggles to meet, with a debt-to-GDP ratio of 119.1% and no clear plan to reduce the deficit.
The government expects debt-servicing costs to rise by more than €10 billion in 2027 compared with this year. "The bar for activating the ECB's bond-buying programme remains high," Brzeski wrote in a separate note last week. For France, he argued, that would at least mean passing its full budget. Acting too early could be "interpreted as monetary financing of the debt of a country unwilling to follow the rules," he warned.
The ECB's other emergency tool, Outright Monetary Transactions (OMT), created in 2012, allows unlimited purchases of short-term bonds but only for countries that first sign up to a bailout programme from the European Stability Mechanism—a step France is unlikely to take. Instead, Brzeski expects the ECB to quietly pause the reduction of its bond holdings, reinvesting maturing debt flexibly as it did during the COVID-19 pandemic.
Meanwhile, social unrest is compounding investor anxiety. More protests are expected this weekend, and Paris police prefect Patrice Faure has advised business owners in a letter to hire private security. Trade unions, unanimously disappointed after meeting Prime Minister Lecornu on Wednesday, have called for a large mobilisation on 5 November. Sophie Binet, head of the CGT, one of France's biggest unions, urged workers to "generalise the strike."
The combination of fiscal deadlock, social tension, and a looming ratings decision leaves France in a precarious position. As the ECB prepares to meet, the message from Frankfurt is clear: the ball is in Paris's court. But with no majority in parliament and protests mounting, the path to a credible budget looks increasingly difficult.
