France faces mounting pressure to reduce its budget deficit, currently among the highest in Europe, as financial markets have already factored in significant risk through elevated yield spreads relative to Germany. Michala Marcussen, Group Chief Economist at Societe Generale, emphasizes that preventing further spread expansion—and the consequent harm to growth and employment—depends on the government maintaining a clear path toward fiscal consolidation. While the likelihood of France violating the European Fiscal Framework and forfeiting ECB protection via the Transmission Protection Instrument remains low, it represents a tail risk under heightened political uncertainty, especially with the 2027 presidential election approaching.
Concerns about fiscal dominance are also gaining traction globally, particularly in the United States, where rising government deficits have sparked fears that central banks may be compelled to maintain low interest rates or purchase sovereign debt to ease financing burdens. This dynamic could lead to stagflation, as historical precedents suggest. Although major central banks are expected to preserve their independence, growing public debt levels and geopolitical economic fragmentation may result in structurally steeper yield curves over time.
Despite widespread uncertainty, economic resilience persists, partly due to anticipatory behaviors such as inventory buildup ahead of anticipated trade disruptions. However, such front-loading often leads to subsequent slowdowns, some of which are now becoming evident. Corporate responses typically include delaying investments, preserving profit margins, and accumulating cash reserves. While layoffs are initially avoided, prolonged uncertainty may force workforce reductions. Recent labor data from the U.S. hints at an inflection point, with job creation slowing and unemployment likely to rise in the coming quarters—potentially paving the way for additional Federal Reserve rate cuts, especially given tighter labor supply from reduced immigration.
In the eurozone, inflation has returned near target levels and growth remains relatively stable, prompting the European Central Bank to adopt a cautious stance. An additional rate cut could still occur as a form of downside insurance. Equally important is the timing of a slowdown in quantitative tightening, which has so far offset rate reductions. From a strategic perspective, now may be an appropriate moment to begin tapering balance sheet contraction.
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Scenario Eco – Societe Generale n nMichala Marcussen, Societe Generale group Chief Economist n nSeptember 2025 n nExcessive imbalances n nWill France secure budget deficit reduction? n nChallenges in securing the French 2026 budget were largely priced by financial markets in the already elevated yield spreads over Germany. Avoiding further spread widening, and the resulting damage to economic growth and employment, however, requires that the French government ensures a downward trajectory for the budget deficit, which today is one of the largest in Europe. We consider a pathway where France choses to breach the European Fiscal Framework, and risk losing the protection offered by the ECB’s Transmission Protection Instrument to be a low probability tail risk. n nPolitical uncertainty is, however, set to remain elevated not least in the countdown to the 2027 Presidential elections. n nIs there a risk of fiscal dominance? n nYield curves have steepened across major markets driven with fears of fiscal dominance, and not least in the US, marking a major contribution. Fiscal dominance arises when a government successfully pressures the central bank to accommodate large budget deficit by delivering low interest rates and/or purchasing government debt to compress term premia. Ultimately this can trigger stagflation as many episodes in history show. n nOur forecasts assume that the major central banks will retain independence, but concerns of burgeoning public debts and geoeconomic fragmentation, also adding inflation risks, is likely to see structurally steeper yield curves. n nWith so much uncertainty, why is growth proving resilient? n nIronically, some sources of uncertainty may initially contribute to growth not least through front loading behaviours. We saw this on global exports ahead of the various rounds of US tariffs, with US importers front loading orders and building inventories. Such front-loading, however, usually comes with payback further down the road and some of this payback is already materialising. n nFaced with uncertainty, corporates will typically delay investment and hiring decisions, seek to protect margins by avoiding price cuts and look to build cash balances. In the first round, corporates will often avoid layoffs, least the uncertainty does not materialise. Faced with lasting uncertainty, and ever more prudent households, corporates will ultimately cut staff. n nRecent employment data suggest that the US is reaching an inflection point where significant layoffs may now follow, and our concern remains that a more substantial slowdown is about to unfold. It is worth note, moreover, that weaker labour supply due not least to weaker immigration, has helped keep the unemployment rate low even as job creation has slowed. Here too we see an inflection point an expect US unemployment to move higher over the coming quarters, opening up to more Fed rate cuts. n nWill the ECB cut further? n nEuro area inflation is back close to target and with growth still proving fairly resilient, the ECB is clearly in wait-and-see mode. To our minds, an additional rate cut could still be on the cards to take out some downside insurance. n nAn additional important question for the ECB is when to slow the quantitative tightening that so far has been leaning against the rate cuts. To our minds, with rate cuts largely done now would be a good time to taper quantitative tightening.