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European markets prepare for French political turmoil

People stand in France's Republique Plaza as they react to the projection of results during the second round of the legislative elections
People stand in France's Republique Plaza as they react to the projection of results during the second round of the legislative elections Copyright Christophe Ena/Copyright 2024. The AP
Copyright Christophe Ena/Copyright 2024. The AP
By Tina Teng
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The second round of the French election forecasts a possible hung parliament, with the left-wing coalition unexpectedly gaining the most seats. Despite political uncertainties, the euro pares early losses.

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Political uncertainties are set to continue driving market volatility in Europe amid the surprising outcome of the French election on Sunday. According to pollsters from the second round of the election, the right-wing New Popular Front (NFP) coalition surprisingly took the lead in the public votes, defeating the far-right National Rally (NR). The NFP is projected to garner between 177 and 192 seats, while Emmanuel Macron's centrist party secured second place with between 152 and 158 seats. The previously projected winner, the NR, led by Marine Le Pen and Hirdan Bardella, may only secure between 138 and 145 seats. While a hung government is the most likely scenario for France, the Prime Minister, Gabriel Attal, has stated he would resign amid the projection. 

Despite the unexpected result, neither party is likely to win an absolute majority, leaving the possibility of a hung parliament in France. The split of political powers will cast increasing uncertainties on critical policies, particularly in government finance.

The euro swings amid political uncertainties

The euro weakened significantly against other G-10 currencies in early June when French President Emmanuel Macron called for a snap election after the far-right party leader, Marine Le Pen, defeated him in the European Union Parliamentary elections. The single currency fell as much as 2% against the US dollar to 1.0664 in the second half of June. The pair rebounded sharply to be above 1.08 last week after the first round of the French election showed that Le Pen's far-right party fell short of winning an absolute majority in parliament. However, Sunday's result put pressure on the euro again, with the exchange rate between the euro and the greenback initially opening lower at 1.08 before a swift rebound to 1.0823 at 2:30 am CEST.

The resilient movement in the euro may suggest that investors are less concerned about a left-wing leading government than a far-right ruling party.  However, the election runoffs remain the key to driving market sentiment this week. Whether the left-wing parties, including far-left France Unbowed, the Socialists, and the Greens, can stay united will be critical for France's future.

Concerns mount amid French public finance

One of the NPF's leaders, Jean-Luc Melenchon, called for the alliance to govern the country and refuse any negotiation with other parties. The alliance's manifesto is to increase public spending, cut the retirement age, raise the minimum wage, and put a cap on the prices of food and energy, which may lead to a larger government deficit. This will further worsen France's finances as its deficit - 5.5% of economic output - is already well above the European Union's (EU) threshold of 3% in 2023.

The EU placed the country under an "excessive deficit procedure" in June when the French elections projected a losing position for President Macron's centrist party. France has to reduce its deficits by 0.5% per year under the new rules, although there are no explicit recommendations for how countries should reduce the deficit until a new commission takes office in November.

French markets may brace for political turmoil

The European stock markets experienced a strong rally after a sharp selloff last week after the first round of the French election as Le Pen's far-right party was unlikely to gain a monopolistic power. The risk premium on the French debt, measured by the 10-year government bond yields, retreated to 3.21% on Friday after reaching an eight-month high of 3.37% earlier in the week. Meantime, the hardest-hit sectors such as banking stocks and green energy shares saw the sharpest rebound. The French benchmark index, the CAC 40, rebounded by 2.7% from its lowest level in June.

The outcome from the second round of the election does not seem to differ significantly from the first round. Investors may be relieved that the far-right party is now less likely to influence governing policies, although the left-wing's spending plans remain a threat to the country's financial stability. However, a hung government could be the best outcome for market sentiment as neither far-right nor left-wing coalition can easily pass on their high spending plans.

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