Unsurprisingly, Standard & Poor's (S&P) have downgraded France's sovereign debt rating to AA–, the fourth-highest score on the US agency’s scale. This move was in response to the country’s worsening public finances: the fiscal deficit has ballooned and debt levels have exceeded output ever since the pandemic, coming in at 110% of GDP in 2023. This is all part of the slow downward slide in France’s credit rating over the past 15 years and should serve as a wake-up call for the government. In the short and medium term, however, the impact is likely to be very small. First of all, it’s part of a wider, global trend. With the exception of a handful of so-called frugal countries, like Germany and Switzerland, debt levels have been rising across the board in recent years. US debt, for example, has long exceeded 100% of GDP, while Japan’s debt is at 250%. It’s true that these two countries are perhaps not the best benchmarks for European states. The US has the dollar’s status as a reserve currency to fall back on, while Japan’s high levels of domestic savings protect it from any onslaught from investors.
France also has the advantage of being pegged to Germany, and the yield spread between the two eurozone heavyweights hasn’t changed since S&P's announcement. What’s more, the current economic environment is good for countries with high debt levels: the cycle of rate hikes is over and central banks are beginning to loosen their monetary policy, which should gradually bring down the cost of government borrowing. In fact, the European Central Bank is expected to announce an initial rate cut this week.
And after slowing sharply in 2023, the global economy is set to pick up again, which will also ease the debt burden. Despite the challenges of an ageing population and funding pensions, and the enormous costs of investing in the energy transition and rearmament, governments need to use this new period of economic expansion to put their finances in order. If they don’t, the bond markets could call them to order, as they often do, when the economy loses steam in a few years’ time. As Warren Buffett so aptly put it, "Only when the tide goes out do you discover who's been swimming naked".
With the Tories’ popularity in free fall after a series of crises, Rushi Sunak has called a general election for 4 July. The latest polls put the Labour Party 20 points ahead and, although that lead could shrink as the campaign progresses, it will be very difficult for the Conservatives to catch up. The financial markets have not reacted negatively to that news – there’s even been a slight uptick in the pound. Labour have adopted a cautious economic policy, which has reassured investors. After all, everyone can still remember how Liz Truss spooked the financial markets with her aggressive fiscal policies during her short stint as prime minister.
Switzerland’s manufacturing PMI did much better than economists had expected in May. It might be at a one-year high, but it’s still in contraction territory, i.e. below the 50 mark.