Fragile French politics contrasts with stabilising eurozone prospects

A political crisis in France and coalition disagreements in Germany threaten to eclipse signs of economic stabilisation across the wider eurozone. We assess the investment outlook as fragile national politics contrasts with favourable fiscal tailwinds.

French politics struggles on with the re-appointment of Sébastien Lecornu as Prime Minister after his resignation last week, and the announcement of a new cabinet. Investors will now focus on whether he can push through a budget this year, with two parties already tabling motions of no confidence in the new government. If this initiative by President Emmanuel Macron fails, the chance of new parliamentary elections rises, with the risk that a vote delivers another stalemate between three political groupings.

If this initiative fails, the chance of new parliamentary elections rises, with the risk that a vote delivers another stalemate 

Despite plummeting approval ratings for Mr Macron, a presidential election looks unlikely, since he can choose to remain in place until his term ends in 2027. Even if fresh parliamentary elections were called, the constitution requires 20 days of campaigning followed by two rounds of voting one week apart. That would leave little time to pass new budget legislation before the year-end. 

We therefore expect political fragility to persist into 2026, after a succession of governments and premiers, keeping French debt costs elevated. Yet while an ongoing form of ‘caretaker’ government may suggest policy paralysis, moves in French government bonds and the euro in recent weeks have been relatively contained. In our view, this reflects some ‘backstops’ that should contain broader risks. The French constitution includes emergency measures, implemented at the start of 2025, designed to keep the government functioning even in the absence of a budget. These measures could authorise restricted public spending from the start of 2026, pending a full budget approval. 

Meanwhile, the European Central Bank could step in with emergency bond-buying programmes to prevent disorderly moves in French debt and its transmission to other countries. 

Germany’s fiscal boost and improving macro prospects

European political instability is not limited to France: fractious and deadlocked politics look increasingly common across many European nations. However, that has not prevented minority governments in Spain, Austria and the Netherlands from passing significant reforms. 

Fractious and deadlocked politics look increasingly common across many European nations

In Germany, coalition disagreements are preventing Chancellor Friedrich Merz from implementing sweeping reforms to welfare spending and de-regulation designed to improve industrial competitiveness. These are much needed: German industrial production fell sharply in August and the economy is still struggling to grow after years of stagnation. Signs of tension within the coalition look manageable for now but could deepen going into 2026. 

Yet despite recent disagreements, the coalition has made progress on measures to restrict long-term unemployment benefits. In March it succeeded in passing significant pro-growth fiscal reforms and in September approved a draft 2026 budget that includes EUR 520 billion of spending, and EUR 126 bn in investment. This fiscal boost in Germany is one factor behind a more stable economic outlook across the euro area. Going into 2026, the German economy – which is roughly a third of eurozone output – should increasingly see the benefit of these spending and investment pledges. 

Businesses across the euro area are enjoying less uncertainty following the US-EU trade deal, while a collective 175 basis points of interest rate cuts from the European Central Bank (ECB) since June 2024 have also helped stabilise the outlook. Manufacturing has seen the biggest boost from easing credit conditions and less tariff uncertainty. Surveys of purchasing managers in both manufacturing and services sectors point to small growth improvements in the euro area. Business confidence also looks stable. Retail sales are growing again after a few tough post-pandemic years. 

Our base case therefore remains that the euro area economy grows by just over 1% this year and next, and that the ECB now keeps rate on hold throughout 2026.

Read also: Rate cuts and rising risks: staying invested in Q4 | Lombard Odier

Investment outlook

European assets could, however, see increased volatility in the coming months, as France struggles to quell political disagreements, and potentially as fresh US demands threaten to cast its July trade deal into question. French sovereign debt already prices in many fiscal and political concerns: 10-year Obligations Assimilables du Trésor (OAT) yields are at levels last seen during eurozone sovereign debt crisis. We expect the spreads between OATs and German Bunds to remain wide and volatile; they could reach 100 basis points if uncertainty persists. Ratings reviews by Moody’s on 24 October and Standard & Poor’s – with its already ‘negative’ outlook - on 28 November could be possible catalysts. Germany’s expansionary budget has raised yields across the bloc at a difficult time for other eurozone members which are on shakier fiscal ground. 

We expect the spreads between OATs and German Bunds to remain wide and volatile

To date, there has been limited spillover from French risks into the bonds of other eurozone members, and to the euro. The spreads between Bunds and ‘peripheral’ countries such as Greece and Italy have narrowed considerably this year. Limited French contagion reflects our view that French political fragility will not morph into a financial crisis that affects the broader eurozone. France’s budget deficit is equivalent to more than 5% of gross domestic product and government debt is around 113% of GDP, putting it among the highest of developed economies – yet its current account is broadly in balance. Thus thanks to excess household savings and strong corporate balance sheets, France is not reliant on foreign financing. 

related content.

investment insights

From Paris and London to Washington, fiscal jitters are back

September 2, 2025

private banking.

learn more

We do, however, expect some volatility in the euro in the coming weeks, and potentially some further consolidation against the dollar. Yet as long as France’s woes do not spread to other eurozone members, we expect a weakening dollar to be the main medium-term driver behind moves in the currency pair. A stabilising economic outlook and German fiscal boost also support our 12-month forecast of EURUSD 1.22.  

Read also: US-China trade stakes escalate | Lombard Odier

Strength in the euro this year has been a headwind for European equities, while French political uncertainties have weighed on French stocks. Following Germany’s big fiscal announcement, valuations of aerospace and defence stocks, insurers and electrification beneficiaries now look very elevated, potentially capping upside for broader European indices. Germany still has a strong reliance on autos and other heavy and traditional industries, in many of which we see limited signs of innovation. Conversely, the earnings outlook for European banks is strong, and we see opportunities in the stocks of selected quality cyclical companies. More broadly, investors are slowly diversifying into other regions outside the US, which is a tailwind for Europe, among other regions.

Overall, our portfolios have a neutral exposure to European stocks, and are underweight in global government bonds; we continue to prefer five-year maturities in European bonds.