French debt risk premium reaches euro zone sovereign crisis levels

By Stefano Rebaudo

Oct 22 (Reuters) - The premium investors demand to hold French government debt over safe-haven German Bunds widened to its highest in 15 years on Thursday, as concerns over France's strained public finances and continuing street protests weighed on sentiment.

French ministers have promised a significantly expanded security operation for further planned protests on Saturday, with troops expected to be deployed alongside additional police. 

France's benchmark 10-year yield was last up 6.5 basis points at 5.06%, after earlier touching 5.1415%, its highest level since July 2002.

The spread over German Bunds expanded to 177.7 bps, its widest since November 2011 during the euro zone debt crisis, underscoring investor unease about France's fiscal outlook.

The key question is whether the European Central Bank would intervene if market tensions intensify, Nomura senior European economist Andrzej Szczepaniak said.

"We believe the bar for the ECB to intervene is very high," said Szczepaniak.

"Things would have to worsen a lot from a contagion perspective before the ECB believes that the moves are sufficiently unwarranted and disorderly that they result in a hampering of the ECB’s monetary policy transmission."

The selloff in French bonds has been driven by political uncertainty ahead of next year's presidential election and difficulties in passing a budget.

"There exists a consensus that Europe is better equipped today to deal with crises, and that European institutions are stronger today than they were 15 years ago, which should make a European response easier to put together," Citi economist Giada Giani said, comparing France's position with that of euro zone peripheral economies during the early 2010s debt crisis. 

"But re-emerging euroscepticism is a constraint here," she added.

French bonds continued to weaken despite data showing an improvement in industrial sentiment in October. 

ING economist Charlotte de Montpellier said the rise in business confidence was a welcome surprise given concerns about the political and economic impact of the unrest.

BUNDS RISE ON SAFE-HAVEN BIDS

Borrowing costs have risen this year as higher energy prices fuel expectations of tighter monetary policy, increasing pressure on highly indebted countries such as France.

Market expectations for ECB rate increases have remained broadly stable in recent weeks, pointing to about three additional rate hikes by late 2027.

Germany's 10-year Bund yield, the euro zone benchmark, fell 7 bps to 3.34%, supported by safe-haven demand despite rising oil prices.

Brent crude futures climbed more than $2 a barrel after further Houthi attacks on Saudi Arabia, while natural gas prices rose to their highest level since December 2022.

Yield gaps over Bunds widened across the euro zone, with Belgium's spread widening 10 bps to 110 bps, its highest since 2012, Italy's rising 10.5 bps to 123 bps, Spain's widening 6 bps to 70 bps and Greece's increasing 8.5 bps to 106 bps.

Germany's two-year yield, which is more sensitive to interest-rate expectations, fell 6 bps to 3.02%.

ECB chief Christine Lagarde said late last month, when markets were pricing in almost four rate hikes by late 2027, that a moderate policy response remained appropriate.

Money markets were last pricing the ECB deposit rate at 3.15% by the end of 2027, implying two quarter-point rate increases and an 80% chance of a third.

(reporting by Stefano Rebaudo; Editing by Toby Chopra and Mark Potter)