Threadneedle’s Fixed income fund manager Martin Harvey comments on the implications of the French government reshuffle.
“The latest developments in France highlight the political strains associated with a stagnant economy, as ministers struggle to agree on the best trade-off between pursuing growth and bringing the budget back into line. The pace of fiscal consolidation has not been as aggressive in France as other nations, indeed government spending continues to contribute positively to economic growth, so squabbling over this is something of a red herring.
“The real problem for the French economy is a chronic lack of growth potential and the measures required to counteract this are both long-term in nature and difficult to find popular support for. Popular support is certainly not something that Mr Hollande possesses at this juncture.
“More broadly, the push-back against aggressive fiscal consolidation has the potential to cause further disagreements at the European level, and the fact that ECB’s Draghi is supportive of greater fiscal flexibility may add fuel to the fire. The French government bond market maintains a sense of calm regarding the disappointing growth outlook and political stresses, as investors are happy to accept the long-term structural risks for the added yield on offer versus German Bunds. Aside from an even-more fractured political fallout in the short-term, this is likely to remain the case, as the ‘hunt-for-yield’ trade continues apace.
“However, we must be aware of the risks that given the current problems, and the apparent lack of a centrist solution, the French electorate continues to gravitate toward the extremes of the left and right wing. This would cause further problems for the European establishment.”