The week ahead

French election might have bigger impact than UK result

The combination of a clear front runner and an emphasis on fiscal discipline by both major parties means UK financial markets have barely even noticed the General Election. In contrast, the French election has caused investors on the continent to panic. The bigger impact on UK financial markets may therefore come from a spillover in financial stress after the French election than from anything to do with the UK’s result on Thursday. 

Admittedly, since the UK General Election was called on 22 May, the FTSE 100 has fallen by 2.3%, but this was down from a record high and it is still up 6% this year. What’s more, gilt yields have fallen. The pound has edged down by 0.7% against the dollar, but is up more than 2% against the euro. These moves make it very difficult to argue that investors are panicking over the prospect of a labour government. Contrast this to the situation in France where the CAC 40 has fallen by 6% and government bond yields have jumped by 30 basis points. 

The situation in France has more than a whiff of the disastrous Truss/Kwarteng ‘mini-budget’, with the two leading French political parities promising to massively loosen fiscal policy and widen an already significant fiscal deficit, which is the second largest in the EU, and has been criticised by Brussels. A far-left or far-right French government would also raise difficult questions about the future of the EU and the euro, further undermining the currency. 

What matters for France also matters for the UK economy. This is because France is our fourth largest partner, accounting for 6% of total trade and 5% of foreign direct investment. Financial turmoil in France, therefore is unlikely to be a tailwind for UK businesses. 

But the bigger immediate risk is of financial contagion. About 10% of UK and Irish bank’s total liabilities were in France at the end of last year and there are large trading volumes in financial assets between the two countries. Remember that the relationship between yields and prices is inverted so yields are rising on French debt because their value is falling, that could represent a loss for British financial institutions on top of any losses incurred by falling French equity prices. If the crisis escalated it could result in a general flight to safety away from Europe, including the UK, which could result in sharp movements in UK financial markets. 

Of course, in this case the European Central Bank and the Bank of England would swiftly step in to ease any liquidity issues. But if there are gyrations in UK financial markets they are more likely to be caused by the result of the French election on 7 July than the UK election. 

In fact, if the new UK government sticks to the sensible policy making set out during the campaign and other countries, such as France the US, take a more populist direction, it may finally be the turn of the UK to be the economic and politically stable one! Here’s hoping.