By Leigh Thomas and Stefano Rebaudo
PARIS, Aug 27 (Reuters) - France faces a particularly perilous annual budget battle in the coming months as political parties jockey for position ahead of next spring's presidential election while increasingly anxious investors look for evidence Paris can regain control of its public finances.
The stakes are high. France already has one of the highest deficits in the euro zone, the election frontrunners are hard-left and far-right candidates pushing expensive platforms,
and governments have a long history of retreating from reforms in the face of street protests and political pressure.
Political sparks will fly in the coming weeks, even before campaigning heats up for the two-round election on April 18 and May 2, as Prime Minister Sebastien Lecornu's government tries to survive the 2027 budget season in a hung parliament.
Investors who spoke to Reuters said they are bracing for months of turbulence, with the budget fight and presidential race feeding off each other to unsettle markets already on edge.
The annual budget cycle has been a source of drama since 2024 legislative elections produced no majority, with two of Lecornu's predecessors ousted over failed negotiations.
Political risks come at a challenging time globally, with borrowing costs from the U.S. to Japan recently hitting multi-decade highs on concern about ever-rising debt loads.
With the presidential race looming, there's no shortage of flashpoints to question France's ability to rein in its deficit just as the Treasury prepares to refinance huge COVID-era debts in the coming years.
Lecornu has urged lawmakers to pass a 2027 budget before the election, warning that they should not "add budgetary uncertainty to all the others" and that financial markets are also scrutinising the presidential campaign.
He has promised "big savings measures" when the budget bill comes before lawmakers in early October. Finance Minister Roland Lescure has floated freezing part of France's pension spending next year to save money, although other details remain scarce.
BOND MARKET ANXIETY
Investors have spent the summer repricing French debt for volatility they expect ahead of the election while tension in the U.S. Treasuries market has added to the pain for France since U.S. bond moves typically spill over to other major bond markets.
The premium investors demand to hold French 10-year bonds over triple-A rated Germany has widened for three straight months, hitting the highest since late 2024 at around 88 basis points.
"I wouldn't be surprised to see those spreads going to 100 bps, and even from 100 basis points, there's space for them to widen further," said Kevin Thozet of French asset manager Carmignac, which manages roughly €44 billion ($51 billion).
Investor doubts about French politicians' commitment to cutting the deficit have helped push French bond yields above Italy's despite Rome's heavier debt burden.
Credit rating agencies are also due to update their views in the coming weeks, starting on Friday with Fitch, which downgraded France's credit score a year ago to a record-low A+.
Even if the government manages to trim its deficit, it will still need to borrow more in the next five years to refinance hundreds of billions of euros in bonds issued at rock-bottom rates during the pandemic.
The government is already struggling to deliver a modest reduction this year - to 5.0% of GDP from 5.1% last year - and parliamentary tensions make a more ambitious 2027 target a tough sell.
"I'm very pessimistic about the ability of either the current president or the next one to deliver the structural reforms needed to reduce the fiscal deficit," said Christopher Dembik, senior investment adviser at Swiss private bank Pictet.
ELECTION UNCERTAINTY
Depending on which candidates end up running next year, in four out five scenarios France would see a runoff between hard-left leader Jean-Luc Melenchon and far-right veteran Marine Le Pen, according to a Harris Toluna poll on Monday.
Both represent dramatic policy shifts, with Melenchon calling for debt held by the central bank to be cancelled and Le Pen advocating lowering the retirement age to 60 for some people.
The poll showed Le Pen winning comfortably against all rivals, though French presidential elections have a history of late surprises.
"There's a lot of unknowns, but in general, it seems like they will all want to ease fiscal policy. There's nobody coming in on a policy that we need to fix the budget deficit, we need to bring the debt down," said David Zahn, head of European fixed income at Franklin Templeton, which manages roughly $1.8 trillion.
(Reporting by Leigh Thomas in Paris and Stefano Rebaudo in Milan; additional reporting by Dhara Ranasinghe and Yoruk Bahceli in London; writing by Leigh Thomas; Editing by Hugh Lawson)
