French debt fears drag euro to 17-month low

French debt fears spread through European bond and currency markets on Monday, pushing the euro to its weakest level against the dollar in 17 months.

At one point the currency dropped 0.8% to $1.116, a level last seen in May 2025. It also lost ground against the pound, the Swiss franc and the Japanese yen. Before Monday, the euro had already posted four straight weekly declines against the dollar, shedding 3.1% over that run.

The pressure comes from Paris, where the government is struggling to pass an unpopular 2027 budget. The plan aims to shrink the deficit and rein in a record debt burden. However, parliament remains deeply split, and political camps are already manoeuvring before next year’s presidential election. As a result, cautious investors sold French bonds and moved into safer German debt.

That shift lifted the extra yield investors demand to hold French debt over German Bunds to 158 basis points on Friday. Traders had not seen such a wide gap since the bloc’s debt crisis of 2011. Meanwhile, the yield on 10-year French bonds touched 4.96% on October 1, the highest reading since July 2002. German Bund yields moved the other way, dropping almost 17 basis points last week in their biggest weekly fall since 2024.

The stress has also spread to other parts of the bloc. Last week, the spread between Italian and German yields neared 130 basis points, its sharpest weekly rise since the COVID-19 crisis. In Spain, Prime Minister Pedro Sanchez called snap general elections on Monday, while Italy will also vote next year. Germany faces its own strains too, after a regional vote last month handed Chancellor Friedrich Merz’s party its heaviest defeat of the post-war era.

Societe Generale chief FX strategist Kit Juckes tied the currency’s slide directly to the sell-off in French debt. “The bond sell-off is triggering bigger moves in any asset considered more vulnerable,” he said. In his view, the forces that held the euro above key levels over the summer have faded. “I think they are gone,” Juckes said, pointing to earlier hopes of brief energy shocks and a weaker dollar.

Bank of America currency strategists estimate that every further 10 basis point widening in the French-German spread matches a 0.4% drop in the euro against the dollar. Goldman Sachs analysts, meanwhile, said in a note that the spread usually has almost no effect on the currency. However, its pull can grow sharply during periods of acute stress. Rate gaps, they added, matter little for currencies “until they are the only thing that matters.”

Andreas König, global head of FX at Amundi Asset Management, said the dollar usually drives the euro/dollar exchange rate. Yet “this time there is also an impact from the euro,” he said. König does not expect the trend to turn in the medium term. He also keeps an overweight position in the US dollar, citing the outlook for US growth and interest rates.

Trading positions point the same way. CFTC data shows traders betting on a weaker euro, and currency options reflect that view. On Friday, the three-month euro risk reversal, a gauge of the cost of options to buy versus sell the euro, slid to its most bearish level since 2024. Analysts say the euro could test $1.10. Juckes also pointed to the euro’s exposure to the yen and the Swiss franc. Against the Japanese currency, it dropped almost 4% in September.

Concerns over French debt centre on the 2027 budget. Prime Minister Sebastien Lecornu’s government has presented a package of around 54 billion euros in savings. The goal is a deficit near 5% of GDP next year, down from 5.4% in 2026. Spending curbs and selective tax measures make up the package. Still, the plan must clear a divided legislature, where lawmakers will likely amend it heavily.

Earlier forecasts from the European Commission, published in May, show the debt load still rising. The Commission sees the ratio of debt to GDP at 120.2% in 2027, up from 118.1% this year and 115.6% in 2025. The same forecast put this year’s deficit at 5.1% of GDP, rising to 5.7% in 2027.

Erik Bregar, who oversees FX and precious metals risk at Silver Gold Bull in Toronto, doubted that voters would back austerity so close to an election. “It just seems to me like the market is rejecting this 2027 budget,” he said.

Speaking in Paris, Marine Le Pen said France should bring its deficit down to 3% by 2030. She goes into next year’s presidential election as the favourite. Over a five-year term, her plan would save a total of 140 billion euros. Meanwhile, PGIM investment strategist Guillermo Felices said whoever leads France must find a consensus in parliament. That consensus, he said, must deliver “budget consolidation that exceeds anything we have seen from France so far.”

Inflation makes the task harder for the European Central Bank. Soaring energy costs have already lifted prices, and higher yields raise borrowing costs for households and companies. French national inflation quickened to 3.0% in September from 2.4%, while the German harmonised rate rose to 3.3%. Further weakness in the euro could therefore leave the central bank caught between fighting inflation and calming bond markets.

Rate markets have also pared back their bets. Pricing now implies an 80% probability that the ECB raises rates once more before the year ends, compared with several hikes expected earlier. ECB chief economist Philip Lane said high energy prices have not yet set off strong follow-on effects in inflation. He said it remained premature to judge if the region had moved into a harsher inflation scenario.

The ECB does have a backstop. Its Transmission Protection Instrument allows it to buy unlimited bonds from a country facing “unwarranted and disorderly” tightening in financing conditions. For now, growth has strengthened, although it remains weak. September brought the quickest expansion in euro zone business activity in nearly 3.5 years, S&P Global data showed.

Pressure on French debt eased on Tuesday. Yields on 10-year French bonds slipped to 4.745% from 4.862%, and the French-German spread narrowed to 135 basis points. The euro recovered just 0.2%, touching a high of $1.1246. Across the region, the STOXX 600 index climbed close to 1%, while the CAC 40 in Paris gained 0.7%. Oil also offered relief, as Brent crude dropped more than 2% to as low as $97.91 a barrel.

Joseph Capurso of Commonwealth Bank of Australia expects more losses for the currency. “We are quite bearish on the euro,” the strategist said. “We believe it will fall below $1.10,” he added. According to Capurso, the euro would need a steep fall in oil prices and firm French deficit control to recover. He also said he does not expect France to tame its deficit anytime soon.

In 2022, Russia’s invasion of Ukraine sparked an energy crisis and sent the euro to a 20-year low. The currency still sits well above that level. However, bond market moves have now become a fresh driver of its decline. Investors will therefore track the French budget debate closely, since further strain on French debt could put more pressure on the currency.