French bond yields reach multi-month lows as Lecornu avoids more gridlock

By Stefano Rebaudo and Amanda Cooper

LONDON, Oct 15 (Reuters) - The French government bond risk premium over safe-haven Bunds tightened further on Wednesday, as fading prospects of snap elections eased political risk, even though analysts cautioned the threat may only be postponed.

By shelving pension reform until after 2027 and appeasing leftist lawmakers who fiercely opposed the 2023 overhaul, French Prime Minister Sebastien Lecornu has managed to stave off a sharp escalation in France’s prolonged political crisis.

French 10-year yields FR10YT=RR fell another 3 basis points in early trading to 3.37%, the lowest since August 15, bringing the decline so far this week to 10 bps, heading for the largest weekly decline since May.

"This averts the event risk (snap elections) for now and might result in further OAT tightening towards 75 bps," said Aman Bansal, senior European rate strategist at Citi.

"However, this also indicates the rising cost of propping up the minority government which might eventually give way to a snap legislative election into the March 2026 municipal election anyway," he added.

The yield gap between safe-haven Bunds and 10-year French government bonds DE10FR10=RR — a market gauge of the risk premium investors demand to hold French debt — was at 78 bps, after dropping to 76.60 earlier in the session. It hit 87.96 bps early last week, the highest level since January 13 on concerns about the French fiscal outlook.

"The proposed 2026 draft budget would aim for a 4.7% deficit of GDP, which is broadly in-line with the previous outlook, and without the pension reform puts the trajectory of deficit/GDP closer to 5.0% over time," Jim Reid, a strategist at Deutsche Bank, said.

"So even though that might read negatively from a debt sustainability point of view, markets were reassured because it was seen as raising the chances that Lecornu would remain as PM and a snap legislative election would be avoided."

France's borrowing costs are among the highest in the euro zone as investors have grown increasingly wary of holding its sovereign debt given the fragility of the government's finances. The 10-year yield FRE10YT=RR dropped 4 bps to 3.365%, its lowest since August 14.

Meanwhile, German 10-year yields DE10YT=RR were down 2.5 bps on the day at 2.58%, having drawn strength this week from mounting trade tensions between the United States and China. It hit 2.579% early in the session, its lowest since July 7.

Concerns about the economic impact of a potential trade war between the U.S. and China prompted investors to boost their bets on future European Central Bank rate cuts.

Money markets priced in about a 70% chance of a 25-basis-point ECB rate cut by July EURESTECBM7X8=ICAP. The ECB key rate is seen at 1.85% in February 2027 EURESTECBM11X12=ICAP from around 2% before U.S. President Donald Trump threatened higher tariffs against China. EURESTECBM11X12=ICAP The depo rate is currently at 2%.

The U.S. and China on Tuesday began charging additional port fees on ocean shipping firms that move everything from holiday toys to crude oil, making the high seas a key front in the trade war between the world's two largest economies.