GBP/EUR Rate Rallies After Leftists Come First in France

Image: France24.

The Euro fell after France threw up a significant surprise: the left came first in the legislative elections. However, they didn't win a majority, meaning a worst-case outcome for the single currency has been avoided.

The polls were wrong; it wasn't Marine Le Pen's RN party that won the election; instead, they came third. Against expectations, a coalition of left-wing and far-left-wing parties secured the most seats and will now have a chance at forming a government.

The Euro's selloff reflects the market's initial unease with this development as France faces a period of political and fiscal uncertainty at a time when its finances are already on a rocky setting. Pound Sterling Live previously reported that a win for the leftist bloc would be a worst-case outcome for French markets and Euro exchange rates. But this outcome was seen as a low-risk probability after its unconvincing performance in last week's first round of votes.

The left-wing New Popular Front (Left Alliance, or NFP) won 182 seats, compared with 168 for Macron's coalition Ensemble and 143 for the far-right Rassemblement National and its allies.

"There is a risk that the hard-left Jean-Luc Mélenchon is appointed prime minister. And even if he isn’t, parliamentary gridlock will hinder efforts to get the public finances on a sustainable footing," says Jack Allen-Reynolds, Deputy Chief Euro-zone Economist at Capital Economics. "We think investors will probably judge that the election has avoided the worst possible outcomes: a majority RN or NFP government. But things still don’t look good for France."

289 is needed to secure a majority, meaning France is set for a 'hung parliament'. To be sure, this was expected; what was not expected was the left being the biggest bloc.

"France now in for period of frantic, chaotic coalition building," says veteran political broadcaster Andrew Neil.

The Pound to Euro exchange rate trades 0.13% higher on the day at 1.1835 and the Euro to Dollar is down 0.16% at 1.0820.

Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole, said recently that GBP/EUR would rise if the New Popular Front (NFP) wins:

"The EUR/GBP 3M-6M outlook would depend on the outcome of the French rather than the UK election. Key in that would be the FX impact of wider government credit spreads to Bund yields after the French vote. Our simulation results suggest that EUR/GBP could dip towards 0.82 or even lower in response to a Left-wing alliance victory."

EUR/GBP dipping to 0.82 "or even lower" equates to a rise in the Pound to Euro exchange rate above 1.22.

But this is Not a Worst-case Outcome for the Euro

The Euro's sell-off is relatively contained because although NFP won, they needed more seats to form a majority. They will be unable to pursue policies that would result in a worst-case outcome for the Euro that involves significant spending commitments.

"Some uncertainty has been eliminated from markets by the results, as public spending in France is most likely not set to rise significantly since both the left-wing and far-right fell short of an absolute majority. A possible majority government in a coalition including Ensemble necessitates compromises and favours status quo given the different views on fiscal policies the parties in a broad coalition will have," says Rune Thyge Johansen, an analyst at Danske Bank.

Image courtesy of Danske Bank.

The NFP has revealed spending plans are significant and would require a sizeable increase in borrowing, something bond markets would struggle to accommodate.

The NFP is a coalition of left-wing parties that includes Jean-Luc Mélenchon’s France Unbowed, the Socialist Party, the French Communist Party and the Greens. It plans to raise the monthly minimum wage to €1,600, impose price ceilings on essential foods, electricity, gas and petrol, repeal Macron’s deeply unpopular decision to raise the retirement age to 64 and invest massively in the green transition and public services.

Prime Minister Gabriel Attal said their agenda would present France with a "fiscal drubbing".

Attal has since stood down following the vote.