France budget short of savings, Europe’s climate tools to test affordability and competitiveness and central banks week ahead

The approval of the social security bill (PLFSS) this week has cleared a key hurdle for the French government to adopt a budget. But the reduction in policy uncertainty comes with a cost: insufficient reduction in government spending. Voting the state budget (PLF) before year-end will be challenging and a Special Law could be used to bridge the funding gap until a PLF is voted in early 2026. If MPs agree on EUR8bn of savings (instead of the EUR22bn needed to achieve the -4.7% of GDP deficit target), the French deficit will be -5.1% of GDP in 2026. On the positive side, GDP growth is expected to accelerate to 1.1% in 2026 from 0.8% this year. Investors signaled a clear preference for a scaled-down budget and government continuity but this technical truce is fragile and political uncertainty can re-emerge any time. OAT spreads should trade in a fair range of 65-80bps in the coming months. The 2027 presidential election may drive OAT spreads temporarily out of this range as political risk increases. Below 100bps for the 10y OAT-Bund spread, no contagion should be expected.

Europe is entering a significant transition in climate policy with the introduction of the CBAM (2026) and ETS2 (2028), which extends the EU carbon price to sectors such as buildings and transport. While limiting carbon leakage, the CBAM will effectively act as a terms-of-trade shock, hitting countries with metal-heavy supply chains, notably Italy (USD8.1bn in levies), Germany (USD6.7bn) and Poland (USD4.4bn). Hungary, Croatia and Romania face the largest tariff equivalents. In a full pass-through scenario, CBAM could add +0.1pp to Eurozone inflation, while ETS2 could add +0.5pp, while the EU27 would on average face +0.9pp cumulatively. Germany faces +0.7pp in price increases while Poland (+2.3pp), Slovakia (+2.1pps) and the Czech Republic (+1.7pps) are most affected. Eurozone GDP growth could fall by close to -0.2pp annually. While these policies are essential to meeting climate targets, Europe will need effective revenue recycling and strategic reinvestment to mitigate adverse competitiveness impacts and reinforce sustainable growth.