By Alun John
LONDON, Oct 19 (Reuters) - French markets tumbled on Monday, with bonds, Paris-listed stocks and even the euro falling after widespread protests across France underscored difficulties the government faces in reducing its large deficit.
Already contending with weak growth and ballooning debt, the euro zone's second-biggest economy witnessed some of its worst unrest in years over the weekend. Thousands of people were arrested and shops were looted during protests over high prices and declining
public services.
France's central government asked some local authorities to impose curfews on Monday, and Prime Minister Sebastien Lecornu did not rule out declaring a state of emergency.
A slide in bond prices on Monday pushed France's 10-year yield up 13 basis points to 4.9%, on track for its largest one-day rise since late September, while the German 10-year yield, the benchmark for the euro zone, rose 4 bps to 3.45%.
The difference between those two yields, which is a reflection of the premium investors demand to lend to France rather than Germany, was 146 bps, its highest in two weeks, though it has eased from the nearly 160 bps hit in early October.
At that point, France's 10-year yield hit 4.99%, its highest since 2002. Yields are now heading back towards that level.
BUDGET BILL AWAITED
Investors say France needs to pass a budget bill to rein in its finances, but the protests demonstrate how difficult this could be. Political jostling ahead of next year's presidential election could further complicate matters.
"The fact this is coming after a weekend of protests shows that hopes for reform are in remission," said Hank Calenti, global market strategist at SMBC, referencing efforts to reduce deficits and reform pensions.
Calenti also noted that the impact was being felt across the euro zone, with investors' hoped-for reforms in several markets looking less likely, and flagged that even German yields were higher on Monday while US yields fell.
Investors, worried the jump in French yields could spill over to other heavily indebted parts of the euro zone, see Italy as the first to watch. Its 10-year yield was up 11 bps on Monday at 4.58%.
The recent moves in French debt also illustrate how the growing role of hedge funds is making the market more vulnerable — a risk regulators are watching closely.
STOCKS, EURO STRUGGLE
French stocks were the worst performing among major European bourses.
The blue-chip CAC 40 index was down 1.5%, compared to a 1% drop in broad European stocks, while shares in two of France's biggest lenders, BNP Paribas and Societe Generale, each fell 3%.
French banks tend to underperform when the gap between French and German bond yields rises, though French retailers were also under pressure. Carrefour fell 1.8%, with its CEO saying the company's losses from protest damage would run into the tens of millions of euros.
The cost of insuring French sovereign debt against an increase in default risk also rose. Its credit default swap rose 5 bps from Friday's close to around 82 bps — still below the October 2 high of 89 bps, but the worst performer on the day.
Ratings agency Moody's will review France's credit rating on Friday, which could result in a downgrade that, in turn, may add some pressure on the country's bonds.
"As Moody's is merely catching up with other rating agencies, however, headwinds for spreads from the downgrade are likely to remain limited," analysts at Commerzbank said.
Developments in France weighed on the euro as well, which was down 0.2% to 0.3% on the dollar, pound and yen on Monday.
(Reporting by Amanda Cooper and Alun John; Editing by Joe Bavier and Jan Harvey)
