Could French bond stress change the ECB's course?

French fiscal and political stress could delay the ECB’s expected rate hikes if widening OAT spreads spill over into other euro-area markets.

• French bond spreads have risen amid difficult budget negotiations, presidential-election polling and social unrest, while persistent fiscal policies could lift public debt to 137% of GDP by 2030.
• At that debt level, France’s interest payments could reach 5% of GDP, making deficit reduction harder and sustaining pressure on its credit rating and demand for OATs.
• Contagion would become a broader European problem if Italian and Greek spreads widened rapidly, especially in shorter maturities, alongside pressure on European banks’ share prices and credit spreads.
• Robeco expects ECB hikes in December and March because of elevated energy prices, but says material and broad-based spread widening could lead to a skipped hike; the speed and breadth of the move matter more than a fixed threshold.
• The ECB could first use verbal support for its Transmission Protection Instrument and might ultimately buy eligible euro-area bonds, including OATs, although moral hazard and the high activation hurdle limit this option.

Takeaway: French OATs face a difficult outlook into the election, but temporary relief rallies or selective purchases remain possible if spreads become sufficiently attractive or political and budget developments improve.