What are the economic stakes in France's second round election?

French citizens are heading back to the polls this Sunday for the decisive second round of legislative elections. This vote will determine the makeup of the French National Assembly, where 577 seats are up for grabs, with 289 needed for an absolute majority.

As voters prepare to cast their ballots, the stakes are high for the future direction of France’s legislative and economic landscape.

In a tactical move to prevent vote splitting against the far-right, Macron’s centrist alliance and the leftist New Popular Front have pulled over 200 candidates from the runoff ballots this week, creating what is referred to in France as the Republican front.

Projections based on five recent surveys indicate that the far-right National Rally (RN) and its allies are expected to secure between 190 and 250 seats. Yet, this would still be insufficient to achieve the 289-seat threshold needed to pass legislation smoothly.

National Rally leader Marine Le Pen, in an interview with French television channel CNews, cautioned about the potential for political gridlock: "If no one gets an absolute majority, and we’re the only ones who can, no bill will be passed."

The leftist New Popular Front is projected to win between 140 and 200 seats, while Macron's centrist group is estimated to secure between 95 and 162 seats.

The second-round election results will greatly influence France's economic policies and market outlook as analysts and economists suggest.

"The lack of an absolute majority would significantly constrain the party from implementing its radical policy agenda. This should prevent a Liz Truss/UK-style fiscal crisis," wrote ABN Amro's senior economist Bill Diviney and rates strategist Sonia Renoult.

Even if the RN secures an absolute majority, ABN Amro believes that market dynamics and EU regulations would likely prevent a worst-case scenario. However, they acknowledge that there will be more fiscal slippage compared to the current administration.

After the first round, the French-German 10-year spread narrowed by about 5 basis points to 75 basis points, but ABN Amro expects it to widen again in the coming quarters.

According to Alexandre Stott, a market strategist at Goldman Sachs, the immediate focus of any newly formed government will be the 2024 budget.

The outgoing government aimed to reduce the deficit to 5.1% of GDP from 5.5% in 2023, with a spending cut of 0.3% of GDP announced in February.

A hung parliament could lead to a slight fiscal slippage relative to this guidance. In contrast, a majority RN government is expected to promptly implement a proposed VAT cut on energy, which would cost around 0.4% of GDP annually without offsetting revenue measures, leading to higher stress to public finances.  

"An absolute majority in the National Assembly would give RN discretion over implementing some of its platform’s costly proposals, such as revoking the 2023 pension reform," Stott wrote.

Goldman Sachs estimates that France's public debt could rise above 115% of GDP by 2026, under a far-right absolute majority.

According to Stott, there is significant uncertainty around fiscal policy in 2026 and beyond as a political deadlock under a hung parliament could lead to new legislative elections and a different government in the second half of 2025.

Moreover, the prospect of the 2027 presidential elections could weaken any government's incentives to deliver substantial fiscal consolidation.

Stott outlines three potential channels for the elections to impact inflation. First, RN's proposed 14.5 percentage point VAT cut on energy—which accounts for 10% of the Harmonised Index of Consumer Prices basket—could temporarily lower French headline inflation by up to 1.4 percentage points.

Second, the expected null-to-negative impact on aggregate demand in both possible outcomes could slightly reduce core inflation.

Third, some of RN's proposals on competition and immigration policy, although partly conflicting with European treaty law, could increase core inflation.