Investors indicate that worries over European debt sustainability are shifting focus from Italy to France. With difficult budget negotiations approaching next month and presidential elections drawing nearer next year, support for both far-left and far-right parties is climbing. For years, Italy's 10-year benchmark bond yield remained notably higher than France's, yet for most of this summer, it has traded below it; bond investors now demand extra risk compensation for holding French debt instead. Rising prices push yields downward.
Investors say this reversal of a historic trend signals a major reassessment of the relative risks between France and Italy. Rohan Khanna, head of European rates strategy at Barclays, noted: "If you ask anyone in the market who Europe's weak link is, the vast majority will point to France. Italy has kicked the ball to France." He added that a combination of "growth risks, political risks, and fiscal risks" is creating a "perfect storm" for French bond investors.
During the eurozone debt crisis over a decade ago, Italy was among the so-called "PIIGS" nations mired in debt, long viewed as one of Europe's riskiest borrowers, with one of the largest public debt stocks on the continent. France, by contrast, was traditionally considered a safer investment choice. However, with both countries facing tough budget talks this autumn and elections next year, investor attention has turned to France's deteriorating fiscal position and the rising odds of electing less market-friendly candidates.
Italy's sustained fiscal austerity, coupled with rare long-term political stability, has won growing favor among global investors. Adam Posen, president of the Peterson Institute for International Economics and a former Bank of England rate-setter, stated: "Italy is now the model of the G7 bond markets." European Central Bank data shows Italy's debt-to-GDP ratio has fallen from 154% in 2020 to 139% this year, while France's has risen from 114% to 117%. Italy has also achieved a primary budget surplus, where tax revenue exceeds spending excluding interest payments, whereas France's budget deficit has widened to over 5% of GDP.
Tomasz Wieladek, chief European macro strategist at T. Rowe Price, remarked: "In the past, Italy was truly Europe's biggest risk point, the country everyone worried about most... But I think France is now quickly following in Italy's footsteps." He added there are signs investors are "reallocating" assets, trimming French bond holdings and adding Italian ones. In recent weeks, French bonds have come under pressure as the government unveils budget plan details, with the full draft budget expected to be submitted to the National Assembly on September 30. French Finance Minister Roland Lescure said this week the goal is to keep the deficit as close to 5% of GDP as possible.
The minority government needs support from the Socialist Party to pass the budget, but the party is likely to oppose cuts to social welfare spending. In both 2024 and 2025, the French government fell over budget deadlocks. This year's budget bill passed only after Prime Minister Sébastien Lecornu agreed to shelve the delayed retirement reform until after 2027, in exchange for the support needed to pass the legislation.
Markets initially feared Italy might resort to fiscal profligacy or adopt a hardline stance toward the EU, but Prime Minister Giorgia Meloni and Finance Minister Giancarlo Giorgetti have earned praise from bond investors for strict fiscal discipline. The budget deficit has fallen from 8% when they took office in 2022 to just above 3% last year. Chris Jeffery, head of macro strategy at Legal & General Investment Management, said he holds a below-benchmark allocation to French bonds and is "moving some positions into Italy." Jeffery commented: "With presidential elections approaching, it's hard to expect many politicians to actively call for budget cuts."