UBS House View Daily

Thought of the day

18.07 - Conditions align for French reforms

Armed with a clear majority, French President Emmanuel Macron has embarked upon a strong economic reform agenda, earning praise from the IMF. He has met initial resistance from his own military chief of staff, who this week appears to have successfully forced the president to backtrack on a tighter defense budget.

But this shouldn’t be taken as a sign that Macron’s resolve is weakening. In our view structural reforms and spending cuts across the government are all but certain:

  • For one, Macron can’t afford to back down. At 56.5%, French government spending as a share of GDP is the highest in the G7 (see Chart of the day below). A July audit revealed a surprise EUR 8 billion gap in the budget, further undermining public finances – and France’s chances of hitting the EU budget deficit target of less than 3% of GDP.
  • Conditions are supportive for reform, with a cyclical upswing in both French and Eurozone economic activity offering a buffer against negative spillovers. Business and consumer confidence are at, or near multi-year highs, and we forecast growth to rise to 1.4% in 2017, its best level in six years. Successful reform would not only improve the fiscal position and lift investment, but also help push unemployment down from the current 9.6% rate.
  • A gradual reduction in corporates taxes, targeting 25% versus the current 33.3% rate, would offer a much-needed boost to competitiveness. And since this will take place over five years, the president will have some flexibility in balancing between fiscal discipline and business giveaways.

So while reforming France isn’t likely to be easy, conditions at last appear to be aligning behind the reform agenda. Success for Macron will not only boost the French economy, but is likely to help speed up German acceptance of deeper Eurozone integration. We remain overweight on Eurozone equities against UK equities, and maintain a six-month EURUSD target of 1.18.

Chart of the day

France’s government continues to outspend its G7 peers

Government spending as a percentage of GDP

Conditions align for French reforms

Source: IMF WEO, Haver Analytics, UBS as of July 2017

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