GBP/EUR Rate Just Hit 1.19

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The Pound to Euro exchange rate has risen to 1.19 ahead of the weekend after a poll showed Marine Le Pen's anti-EU integrationist party on course to win a parliamentary majority in France's legislature.

Pound Sterling extended gains against a broadly weaker Euro through Thursday and into Friday after polls showed the National Rally (RN) was gaining momentum, raising fears for France's debt outlook. A surprise decision by left-wing parties to form a coalition will also worry President Macron and investors, with talk of the centrist President facing an electoral wipeout.

"A possible victory for Le Pen's party in the snap elections for the National Assembly is putting pressure on French government bonds," says Dr. Jörg Krämer, Chief Economist at Commerzbank. Falling French bonds are meanwhile pressuring the Euro.

RN is on course to increase its parliamentary seats from 88 at present to 220 to 270 seats in the National Assembly, a survey by Elabe for the news channel BFMTV showed. Such an outcome would mean Jordan Bardella, the 28-year-old leader of RN, will be Prime Minister, ensuring France's President and Prime Minister will come from two separate parties.

Trouble for Emmanuel Macron is also coming from the left, where a number of parties have agreed to form a coalition, which gives them a shot at winning a majority. The left might be more pro-EU, but their spending plans and broader agenda risk blowing up France's already significant budget overshoot.

Fears about France's fiscal outlook are growing, and markets are expressing unease by selling French debt (bonds). The Pound to Euro conversion has hit the psychologically significant 1.19 mark as a result of recent developments, and competitive payment providers are now offering rates in excess of 1.1850.

Bruno Le Maire, Minister of the Economy, warned France risks a financial crisis. He was asked by Franceinfo radio on Friday whether the current political situation in the country could lead to a financial crisis, and his answer: "Yes."

Investors will be watching the difference between the yield offered by falling French bonds and the yield offered by safe-haven Germany. France's yield is rising quickly relative to Germany, meaning investors are uneasy about France's prospects.

As the chart below shows, GBP/EUR rises alongside the spread between German and French bond yields. As long as fears regarding France linger, Pound Sterling can remain supported:

Above: French-German spread (top) and GBP/EUR. Track GBP/EUR with your own alerts, find out more here.

Krämer explains that the RN and other populist European political movements want to limit the EU to a confederation of states with a Commission that carries out the orders of the heads of state and government "like a mere employee".

"Now, one can argue about the desired depth of integration of the EU. But a monetary union is simply not compatible with member states acting autonomously," says Krämer.

For the Euro project to work, the constituent countries must be broadly aligned in terms of how much they spend, meaning there must be a degree of budget discipline.

Recall the Greek debt crisis in the early 2010s, which morphed into a broader crisis for the Eurozone as other 'periphery' countries also started to see their debt come under pressure. Greece has since carried out difficult reforms and now displays the kind of fiscal discipline compatible with using a single currency.

The Eurozone and EU have fiscal rules to ensure countries live within their means to ensure the smooth functioning of the Euro. The growing fear is that France, with its rising debts, will be a source of similar problems, particularly with a government that does not subscribe to Eurozone fiscal rules.

"A weaker euro, French equities underperforming, and France’s bond spread spiking have little to do with the European elections. And everything with the complete lack of budget discipline!" explains Jeroen Blokland, Founder of the Blokland Smart Multi-Asset Fund.

If French budget discipline is lacking now, an anti-EU integrationist movement in France could be problematic if it outright rejects the EU's fiscal rules.

The European Commission has warned France's budget for 2024 means it is at risk of flouting fiscal guidance. The EU will this year reinstate debt and deficit rules that it suspended during the pandemic.

The Commission subsequently told the French government to take the necessary steps to meet the EU’s fiscal rules.

Macron’s government was already struggling to balance the country’s fiscal profile with voter demands for more spending. Debt as a percentage of economic output is expected by the Commission to rise to 110% of gross domestic product by 2025, according to forecasts released in late 2023.

Credit rating agency Standard & Poor's last Friday cut France's credit rating, pouring cold water on the French government's recent efforts to put its public finances back in order.

The agency lowered France's credit rating from AA to AA−, citing larger-than-expected deficits and political fragmentation as reasons for the downgrade.