France’s crisis is sending shockwaves through European bond markets, reviving concerns that financial pressures could spread to other heavily indebted eurozone economies. However, despite political paralysis, social tensions and deteriorating fiscal prospects, a repeat of the debt crisis that shook Europe around 15 years ago is considered unlikely, at least for now, according to an analysis by The Wall Street Journal.

The eurozone appears to have learned important lessons from the previous debt crisis, strengthening its safeguards against potential market turmoil. At the same time, most of its economies are in better shape today than they were in 2010, reducing the likelihood of wider instability.

French bond yields reach their highest levels in decades

In recent weeks, French government bond prices have fallen more sharply than those of other European countries, as investors question the government’s ability to address the country’s fiscal problems.

Political paralysis and violent protests ahead of the April elections threaten to delay necessary measures to rein in the widening budget deficit and rapidly rising public debt.

The pressure has already been particularly pronounced in the government bond market.

French bond yields have surged to their highest levels since the early 21st century, while the yield spread over German bonds, which are considered a safe haven for investors, has widened to its largest level since the European debt crisis.

The development reflects growing market concerns about the fiscal trajectory of the eurozone’s second-largest economy.

At the same time, France’s difficulties have caused some turbulence in the bond markets of other countries with high levels of public debt, including Italy and Greece.

Nevertheless, current conditions differ significantly from those that led to the previous crisis, limiting the risk of widespread contagion.

Why the eurozone is more resilient than in 2010

One of the main reasons economists are less concerned is that most eurozone economies are now in better shape than they were in 2010.

Their dependence on external financing has also fallen significantly, reducing their vulnerability to a sudden shift in international investors’ attitudes.

This applies to France as well as to the economies that were at the centre of the previous crisis, with the exception of Greece.

“Financing needs are much smaller,” said Samy Chaar, chief economist at Lombard Odier.

One of the most important indicators used to assess an economy’s dependence on foreign capital is its current account deficit.

This indicator measures the difference between a country’s income from exports of goods and services, as well as investment returns, and the corresponding payments it makes abroad.

When an economy faces a debt crisis, this deficit is usually particularly large, signalling a substantial need for external financing.

Greece’s experience and the crucial differences with France

The figures from the previous European crisis are instructive. In the four years leading up to the start of Greece’s debt crisis in 2009, the country recorded an average current account deficit of more than 10% of annual gross domestic product (GDP).

Portugal faced similarly large deficits, leaving both economies particularly vulnerable to a potential interruption in external financing.

France’s position today is markedly different.

Over the four years up to and including 2026, the French economy is expected to record an average current account deficit of about 0.6% of GDP, far below the levels seen in the most vulnerable countries before the previous crisis.

Indeed, in the previous year, Ireland, Italy, Spain and Portugal recorded current account surpluses, meaning their total income from abroad exceeded their corresponding payments.

In other words, even if the French government spends excessively large sums on pensions, increasing public debt, the French economy as a whole is not heavily dependent on foreign financing.

This difference is crucial.

Heavy reliance on foreign capital can turn a serious fiscal problem into a full-blown crisis if investors suddenly lose confidence and cut off funding.

In France’s case, this vulnerability is considerably smaller, reducing the likelihood of a crisis on the scale of the one that hit the eurozone around 15 years ago.

The eurozone’s major problem: 21 separate bond markets

Beyond the improvement in economic fundamentals, there is another important reason why the eurozone appears better prepared: it now has mechanisms specifically designed to address weaknesses in its own institutional architecture.

Unlike other major economic areas, such as the United States, the eurozone consists of 21 separate sovereign bond markets.

This means that problems emerging in one country can, under certain circumstances, spread to others, even when their own economic fundamentals have not deteriorated significantly.

This phenomenon was seen in Greece from 2009, in Italy in 2018, and is now a concern in France.

In such cases, government bond yields can rise across several member states, not necessarily because their fiscal positions have worsened, but because investors are concerned about the wider stability of the monetary union.

The most important change compared with the past is that the European Central Bank (ECB) now recognises this risk as a structural weakness of the eurozone.

It no longer assumes that every instance of contagion is necessarily the result of fiscal irresponsibility or poor economic management.

Instead, it treats the phenomenon as a risk that must be contained before it causes serious damage to member states’ economies.

The ECB’s ‘weapon’ against another debt crisis

At the forefront of the European Central Bank’s defences is the Transmission Protection Instrument (TPI), announced in July 2022.

The tool was created to address “unwarranted and disorderly market dynamics” that can trigger a sharp rise in government bond yields.

Under the TPI, the ECB can purchase government bonds with maturities of up to 10 years if it considers market pressures unjustified by underlying economic fundamentals.

Crucially, there is no specific upper limit on the volume of these purchases.

This gives the central bank a potentially powerful means of intervention, aimed at preventing an uncontrolled rise in borrowing costs.

Activation of the mechanism is not automatic, however, and is subject to specific conditions.

Nevertheless, most eurozone countries appear capable of meeting the eligibility criteria for support if they experience a sudden rise in bond yields that is not attributable to their own fiscal policies.

Can the ECB intervene to support France?

The key question is whether France could benefit from the mechanism, given that the European Union has ruled that the country is breaching its fiscal rules.

France is subject to an excessive deficit procedure, which some economists believe could stand in the way of activating the TPI.

However, the issue is not clear-cut.

A government may remain eligible for support if it is making efforts to put its public finances back on a sustainable path and is following the European Commission’s recommendations.

Therefore, the fact that France is subject to an excessive deficit procedure does not necessarily rule out all possibility of ECB intervention.

“The TPI’s very concise activation rules are probably flexible enough to allow such an intervention in support of France,” said Gilles Moec, chief economist of the AXA Group.

However, he warned that the central bank’s room for manoeuvre would be significantly reduced if Paris failed to comply with its European fiscal obligations.

“ECB intervention becomes more difficult if France openly fails to comply even with the minimum requirements of the European fiscal surveillance framework,” he stressed.

How France’s crisis is affecting interest rate decisions

Beyond its dedicated tools for intervening in bond markets, the European Central Bank has already taken a simpler step that is helping to ease pressure on France and other European governments.

Specifically, it has sought to curb investors’ expectations of further interest rate rises.

Following the rate increase in September, markets had been pricing in further moves in the same direction.

Each additional rate rise could have pushed French government bond prices down further, intensifying pressure on the country’s borrowing costs.

Recently, however, ECB officials have begun to play down the prospect of further changes to interest rates.

This shift is helping to contain market concerns and reducing the likelihood of additional pressure on government bond yields.

“The situation in France reduces the pressure on the ECB to raise interest rates,” said Carsten Brzeski, head of macroeconomic research at ING.

Thus, despite the serious fiscal challenges facing Paris, the eurozone appears to have more tools today to contain the impact of a crisis in an individual country and prevent it from escalating into wider turmoil.

Whether these safeguards will prove sufficient depends both on how France’s political and fiscal crisis develops and on the ability of European institutions to intervene effectively if market pressures intensify.