Locked in a protracted political crisis over the extent of its indebtedness – and with its deficit running at over five per cent of GDP – France has earned itself the unwanted monikers of ‘the sick man of Europe’ and the ‘new Greece’. Despite these woes, its borrowing costs remain lower than the UK’s. Ali Lyon explores why.
If – as James Baldwin famously observed – the most dangerous creation of any society is the man who has nothing to lose, then the dying days of Francois Bayrou’s premiership could have spelt the end of France as we know it.
Over August and early September, the then-prime minister knew that France’s parliamentary arithmetic left his government facing an impossible task to push through its austerity-lite Budget, a task that had already toppled two of his predecessors.
But rather than making a flurry of last-minute concessions to opposition parties, he embraced the nuclear approach few Western politicians are willing to do: reckon with voters on the extent of their country’s fiscal woes.
“The present is putting us in great peril,” he said in what he knew would be his final address to French lawmakers before a vote of confidence in his leadership. “If we don’t cut our spending, we are heading into bankruptcy. We will not be able to borrow a single euro more.”
“I see a ship that is taking on water,” he went on to say, “our urgent duty is to make our ship waterproof,” before concluding: “Our debt is a Damocles sword hanging over our country and our social model.”
Even a cursory look at the numbers proves the veteran politician – who lost his vote of no confidence earlier this month, forcing President Macron to appoint his fourth prime minister since the start of last year – was not wrong.
France’s runaway economy hit a breathtaking €142bn (£124bn) budget deficit in 2024, equal to some 5.8 per cent of its total output. That shortfall helped take its debt to GDP ratio to 138 per cent, second only to a post-economic-crisis Italy as the most indebted major European economy.
Francois Bayrou’s premiership lasted just nine months, after his calls for fiscal prudence fell on deaf ears (Photo by Aurelien Meunier/Getty Images)
The outlook for the European powerhouse is almost bleaker than its present. Its economy is expected to expand by a meagre 0.6 per cent this year, suggesting the notion of it “growing its way out of trouble” is a chimera.
And according to the country’s central bank, labour productivity – a key metric for how vibrant and high-skilled an economy is – has fallen some 8.5 per cent relative to the pre-Covid trend.
Hedge fund colossus Ray Dalio and Barnoess Morrisey have both said the UK is in a ‘debt doom loop’
Add in the febrile political environment that has lasted over a year, and took Bayrou as one of its many casualties, and over which looms the spectre of a government led by Marine Le Pen’s economically left-leaning populist National Rally, and the extent of the country’s fiscal plight becomes even clearer.
And yet, the interest it pays on its 10-year government bonds – the security used most often as the indicator of a country’s capacity to borrow – is a full percentage point lower than the UK’s borrowing costs.
The French Ministry of Finance currently pays 3.59 per cent on its 10-year loans. Fixed income investors interested in buying gilts – the name for UK government bonds – force our cash-strapped Treasury to fork out an annual interest of over 4.73 per cent at the time of writing.
As this would suggest, the UK’s own fiscal position is hardly the envy of the world. Indeed, both Ray Dalio, the hedge fund colossus and founder of Bridgewater Associates, and the former Newton chief executive Baroness Morrissey, have used recent interviews to say the country is in a “doom loop”, where it is forced to raise taxes to plug fiscal holes, thereby extinguishing hopes of rekindling economic growth.
But on almost all of the aforementioned economic indicators that illustrate France’s dire financial straits, the UK outperforms its Gallic neighbour.
Its debt to GDP ratio remains below 100 per cent (for now). Its deficit may have been a gaping 4.8 per cent last year, but not as gaping as the one being run across the English Channel.
And while Fitch’s credit rating for the UK remains ‘high grade’ at AA-, earlier this mont,h the agency downgraded France’s sovereign debt to A+, taking it into the ‘upper medium’ grade bracket.
And even with the daily psychodrama emanating from SW1, Starmer’s glitching government still has a chunky majority and is likely to remain in office – with its flawed but important ‘fiscal rules‘ – for another four years.
Why are the UK’s borrowing costs so high?
Economists agree that – were one purely to look at the reliability of the borrower – France’s borrowing costs should be higher than Britain’s.
“At first sight, French government bonds are a riskier investment than UK bonds,” said Julian Jessop, an independent economist who sits on City AM’s Shadow Monetary Policy Committee. “Indeed, this is reflected both in sovereign credit ratings and in the probability of default implied by pricing in the Credit Default Swap market.”
But other drivers are helping gilt yields to approach post Great Financial Crash (GFC) highs. Chief among these is the UK’s sticky inflation outlook, and what that is likely to mean for the country’s main interest rate. A look at what is known as the 10-year ‘swap rate’ between the two countries, which essentially represents the best estimate of interest rates on that time horizon, shows investors think inflation will remain elevated in Britain. The 10-year swap rate is currently fluctuating around 4.10 in the UK, compared to 2.70 in the Eurozone.
“Fundamentally, investors think the UK’s inflation outlook is more problematic than Europe’s and that will prevent the Bank of England from taking rates back – on a sustained basis – to the sorts of levels we see in the Eurozone,” James Smith, an ING economist who leads the bank’s coverage of the UK, told City AM.
This is important because inflation is the bête noire of bondholders. If – to take a simple example – prices are rising at five per cent a year, and the government bond you, as an investor, own is paying an interest of four per cent a year, then you have immediately lost one per cent in real terms. A higher inflation outlook, therefore, will force investors to demand a higher interest rate, so they can reinstate that buffer to make lending profitable.
Helen Thomas, the chief executive at political economy analysis shop Blonde Money, pointed to three other factors that might also be helping keep a lid on France’s borrowing costs. Being part of the Eurozone, she says, France’s government bonds are more liquid than the smaller pool of GDP-denominated gilts.
And having its own currency gives Britain the option of devaluing its way out of any credit-related troubles, which, while fraught with long-term danger, does allow a country a reprieve on which France, and other Eurozone countries, don’t have the luxury of being able to lean.
“That means investors require a higher return (in terms of a higher yield) to compensate for the risk of holding its bonds,” she added.
Tightening the screw
Jessop identified another factor that could be driving down the value of the UK’s bonds, which move inversely to yield: the Bank of England’s unusual approach to unwinding the era of central bank bond purchases that followed the GFC.
Unlike the US’s Federal Reserve or the Eurozone’s European Central Bank, the Bank of England has adopted an ‘active’ approach to this process – known as quantitative tightening – meaning it is selling bonds into a market that already has surplus supply.
“The Bank of England has been selling its holdings of government bonds relatively aggressively under the policy known as Quantitative Tightening (QT), at the same time as demand from defined benefit pension funds has fallen sharply,” he said.
The Fed and ECB are – by and large – taking a more patient approach to shrinking their balance sheet, and waiting for the bonds they hold to mature. Until this month, the Bank has been offloading £100bn of gilts a year. Officials chose to slow that to £75bn at this month’s interest rate decision, albeit in a way that involves more active sales than in 2025.
In adding to the supply of gilts at a time when the government is already borrowing at the same rate as during the pandemic, the Bank has, Jessop argued, chosen to drive down the value of our government bonds further still.
As for France, the new Prime Minister, Sebastien Lecornu, needs to table his Budget in October and is frantically courting support from the very parties that sealed his predecessor’s fate. The condition they’re setting to push through his fiscal plans? “Tax justice” and, naturally, no spending cuts.