Euro Slumps as French Unrest Rattles Bond Markets

Protests fueled by the cost-of-living crisis left a trail of damage across French cities over the weekend, resulting in thousands of arrests. This volatility intensified pressure on the government, which is currently struggling to pass budget measures designed to trim a stubborn deficit. Investors responded by dumping French government bonds, pushing the spread between 10-year French and German yields to a two-week high of 146 basis points.

Patrick Munnelly of the Tickmill Group noted that the combination of social instability and fiscal uncertainty is exerting significant downward pressure on the currency. The contagion is already spreading, with unrest spilling into Italy and fueling fears regarding future election outcomes. MUFG Bank analyst Lee Hardman warned that the perceived rising probability of a win for National Rally leader Marine Le Pen remains a primary headwind for the euro heading into next year.

These mounting risks have forced a recalibration of European Central Bank expectations. Markets now assign only a 10% probability to a rate hike at the October 29 meeting. While UBS economists maintain a forecast for a December increase to 2.75%, they acknowledge that if French turmoil persists or bond market conditions tighten further, the central bank may be forced to halt its hiking cycle prematurely.