Political uncertainty is affecting the euro. The crisis in France is limiting the ECB’s room for manoeuvre

The rapid rise in French government bond yields has weakened the euro in recent weeks, complicating the ECB’s task as it grapples with inflation that rose to 3.8 per cent in September. Yesterday, the euro fell to around 1.12 dollars – its lowest level since May 2025 – before also losing ground against the Swiss franc and the pound. The spread between French and German 10-year bonds exceeded 150 basis points on Friday – the highest since 2011 – as the French government struggles to get its 2027 budget approved, which is expected to reduce the deficit to at least 5 per cent. There are therefore fears of contagion spreading to other heavily indebted countries, with Belgian and Greek bonds already under pressure, as well as those of Italy (where fiscal prudence has not prevented the spread on BTPs from rising by around 30 points in recent months).

In Spain, however, the snap election called yesterday by Prime Minister Pedro Sánchez had little impact on the markets as it had already been priced in for days. The markets are now wondering whether the ECB will use the TPI, the instrument created in 2022 to buy a country’s bonds when yields rise in an ‘unjustified and disorderly’ manner. Buying French government bonds would lower their yields and make it easier to borrow, which is the opposite of the ECB’s monetary policy since June, when it raised interest rates for the first time since September 2023. Furthermore, France is unlikely to meet the TPI’s criteria, as its yields are rising due to political irresponsibility rather than irrational market turmoil. Using it now would only risk undermining the ECB’s credibility, but failing to use it in the future would become more difficult if the sell-off were to spread indiscriminately to other countries.

Meanwhile, inflation and debt have become a constant problem for European stock markets, with the Stoxx Europe 600 index recording its fourth fall in the last five weeks last week. Europe is now facing a multitude of crises: political, energy, housing, debt and inflation.