Politics gets in the way

With no party or coalition securing an absolute majority in the July 2024 elections, the divided National Assembly has increased uncertainty for the economy. For instance, voting in the 2025 draft budget bill in October-November could face hurdles in Parliament amid political infighting. Besides, financial conditions are a bit tighter than they would have been under a no-election scenario. However, we expect the French government to deliver much less fiscal consolidation than was planned pre-election, if at all. In all, we estimate that a looser fiscal stance will fully offset tighter financial conditions and increased uncertainty, meaning that our scenario of a pick-up in GDP growth in 2025 remains in place. A key risk to our forecast is if further political infighting continues through the fall, and the government could be taken down by a no-confidence motion. Furthermore, although this is a tail risk, President Macron could resign before the end of his term in 2027. This could usher in a period of high volatility in financial markets and lead to tighter financing conditions.

Better growth momentum in 2025 will be driven by lower funding costs – as the ECB will accelerate its easing cycle – and lower energy costs and inflation supporting households’ purchasing power and corporates’ margins. There are already signs that private agents, for instance, are already benefiting from or anticipating looser financial conditions in 2025: the demand for mortgage loans has picked up significantly and net issuance of bonds by large corporates has accelerated. Nevertheless, corporate bankruptcies will remain high, though declining, heading into 2025. Many SMEs and medium-sized companies are feeling the pinch of low demand and tight funding conditions, and have low pricing power, especially in construction, retail, hospitality and household services. From a margin perspective, the situation looks much better in the manufacturing sector than in services overall. 

Inflation has continued to normalize over the past months. Moderating wage growth, anchored inflation expectations, and still soft demand should continue to keep a lid on prices in 2025.  

France’s labor market has held up remarkably well since the pandemic. The unemployment rate has dropped while net job creations were the most dynamic among the large, developed nations since the pandemic, especially for the young. The labor participation rate picked up sharply to reach its highest recorded level. Despite weakening hiring intentions, unemployment is not expected to increase by much amid large labor shortages. Labor market strength is an important buffer against fading economic momentum.

Nevertheless, dynamic employment is partly the by-product of poor productivity performance. Abundant labor, sizeable hiring of young people and labor hoarding have weighed on French productivity, which sits well below its pre-pandemic level. More concerning is that the underlying efficiency of labor seems to have decreased. Dynamic investment through 2022 and an expected increase in youth work efficiency (notably apprentices) should sustain an improvement of labor productivity in the next couple of years but we do not expect a return to the pre-pandemic implied path. The continuous drop in school proficiency for French students and poor skills of the labor force are a big headwind for future productivity growth. Furthermore, long-lasting structural issues (e.g., the lack of qualified workers, skill mismatches and little incentives to start work) are likely to prevent the unemployment from dropping significiantly below 7% in the coming years.

Export performance is an area where France continues to underperform. French export volumes are a bit below their pre-pandemic implied path, held back by low exports of transport materials. On the positive side, exports of services have been dynamic since the pandemic. Export performance has been held back by a wide range of structural issues. The government has rolled out ambitious industrial subsidies to try to shore up manufacturing and exports but incentives for corporates to restore production in a country with low potential growth are weak. To boost the post-Covid-19 export recovery, the challenging sectoral specialization (e.g., aircraft and automobiles), poor price and quality competitiveness and the lack of qualified (technical) workers are amongst the chief issues to address.