Rising borrowing costs in Europe are forcing politicians to cut back on spending as markets and investors demand increased fiscal discipline. With rates rising from France to Italy to the UK, governments face a dilemma of having to contend with higher debt cost while also keeping cash on hand to fund spending needs.
Earlier this month, the downward shift in the price of French government debt gathered pace, with yields reaching levels not seen since 2002. There is a growing nervousness over France’s heavy budget deficit, the divisions between its political parties and the presidential election due in 2027. The move is part of a wider reassessment of borrowing risk across the continent.
France has become a primary area of concern for investors. The government’s budget deficit is projected to surpass 5% of gross domestic product in 2026, which is above the European Union’s reference threshold of 3%. At the same time, France intends to issue around 340 billion in bonds in 2027 to support government operations and refinance existing debt.
French 10-year government bond yields have increased around 80 basis points since early September and are close to 5%. There has also been a widening of the spread between French and German borrowing costs, meaning investors now require extra returns to lend to France instead of Germany.
European finance ministers and the European Central Bank have called for the French government to deliver a credible 2027 budget to begin rebuilding trust. But political disagreements have kept the government from able to ensure that its planned spending cuts and other budget measures have enough support from parliamentarians.
It shows how bond markets can act as a constraint on governments without a direct intervention. Higher yields sought by investors means an increase in the cost of new borrowing and a higher proportion of tax revenue going to interest payments.
The country is not alone either. Italy and Spain have also seen borrowing costs go up as markets begin to worry about public finances, political uncertainty and economic prospects.
Meanwhile, the rise in yields has been driven by global factors such as inflation worries, trends in central bank interest rate outlooks and mounting government-bond issuance. In September, average euro-area 10-year government bond yields rose toward 4%, their highest in more than 10 years, as the European Stability Mechanism.
The effect will differ across countries. Countries that have high debt, big refinancing needs and less buoyant growth are more vulnerable, as they have less flexibility to deal with rising borrowing costs. Countries with more fiscally robust positions may be better placed to support investor confidence.
The UK has also come under pressure in the government bond market. An increase in gilt yields has heightened the investigation of the government’s fiscal stance ahead of the Autumn Budget.
More expensive borrowing may reduce the funds available for spending on public services, infrastructure, and other spending priorities. It can also constrain policymakers’ ability to implement tax cuts or additional spending that does not rely on explaining how they will be paid for.
