In the second round of the French parliamentary elections the choice became one of political paralysis or a government led by the far-right. A pact of coordination between the centre and the left was formed to reduce the chances of the latter. Arguably, this pact has been successful, but the outcome looks like a classic case of unintended consequences, where the left have ended up with more seats than expected.

Our recent European Espresso video covered expectations following the first round of Macron’s snap parliamentary elections. The second round delivered a result today that went against wider expectations with no single party commanding a majority and taking us into a period of political wrangling as a coalition government is formed. It seems most likely that the left-wing alliance (New Popular Front: 182 seats) will be at the forefront of negotiations, alongside the centre (Ensemble Alliance: 168 seats). The surprisingly poor showing from the far-right (National Rally: 143 seats) will likely keep them from having a prominent role in these discussions.

What does this mean for policy direction? The key to likely policy direction will be the make-up of the final coalition government. In broad terms, there are two potential outcomes. The first is some sort of a broad ‘grand’ coalition led by the centre, bringing in representation from the left and the right. This would be seen as a favourable outcome for markets.

The second potential outcome is a coalition formed around the New Popular Front. This would be seen as a less favourable market outcome, but the balance of power within the New Popular Front would be a crucial factor. Finally, if political wrangling reaches complete deadlock, some sort of a technocratic government would be the likely outcome. This would be a benign outcome for markets. The more left the coalition is, the more the market will worry about a potential rise in government spending, a possible reversal of pension reform, price freezes, state salary increases and a worsening relationship with the EU. As we know, France already has a debt to GDP ratio above 100%, so any net increase in government spending would come under particular scrutiny.

In the long term, the events of the last few weeks are problematic from an EU perspective. A strong EU needs a strong France almost as much as it needs a strong Germany. With the political situation becoming less clear in both countries, the EU project will need new impetus. As a desk, the general view was to reduce exposure to French assets when President Macron announced his snap election, reflecting the rise in uncertainty. With the French election approaching its end game, consensus is more towards identifying opportunities for investment. However, our bias towards globally relevant businesses, rather than those that are more domestically-focused, will remain a feature of our thinking.

JHI