(Bloomberg) -- Bond investors are set to impose a higher interest rate on French government borrowing for years, in a regime change that could have far reaching consequences for Europe’s second largest economy.

Even if Marine Le Pen’s National Rally falls short of an outright majority in the upcoming vote, Zurich Insurance Company and Neuberger Berman say the market will continue to demand a higher yield to buy French debt. Others, including Societe Generale SA anticipate the political uncertainty that has weighed on bonds will persist until the 2027 presidential election.

Since President Emmanuel Macron called a snap vote earlier this month, the French 10-year bond yield has jumped more than 30 basis points, and is currently hovering around 80 basis points - a level last seen during the euro-area’s sovereign debt crisis more than a decade ago.

“We’ve had a step change of where France is going to trade relative to Germany,” said Guy Miller, the chief market strategist at Zurich Insurance Company. “I just don’t think that French bonds will trade again at the level of the spread they had in the past.”

The drivers for the repricing are twofold. Le Pen’s party, which commands a sizable lead in the polls, has touted some costly budget measures despite mounting concerns over France’s debt burden — though it has wound back some of the promises in recent days at it seeks more credibility on the economic matters.

And there’s a fear — on the margin at least — that the far-right’s rise would fracture relations with the EU and could someday pose a challenge to the euro-area’s existence.

Whether French bond yields are likely to settle at a higher level has far-reaching consequences for the economy. France’s finance ministry estimates the steeper price of borrowing would cost the state an additional €800 million ($859 million) a year. If the level persists, after five years, the additional annual cost would be around €4 billion to €5 billion, and as much as €9 billion to €10 billion after 10 years.

Societe Generale warns this risk premium is likely to linger even if Macron’s party surprises pollsters by clinching a parliamentary majority over the coming weeks. That’s because a stronger far-right contingent could still complicate the law making process and stand in the way of reforms.

Even in the “best-case scenario” for markets of a majority for Macron’s party, “the idiosyncratic premium on French bonds could shrink, but not fully disappear,” said Adam Kurpiel head of rates strategy at Societe Generale. 

In this scenario — which bucks current polling — the French-German spread could tighten, but not below the 50-to-55 basis point range, he added, while a National Rally win could see the spread find a new equilibrium in the 75-to-90 basis point area.

“The risk of a change of OAT regime could hence be underestimated by the authorities,” Kurpiel said.

France’s first bond sale since Macron called the snap election this month went as planned on Thursday, a sign yields are high enough to entice new buyers. The Treasury in Paris raised €10.5 billion ($11.3 billion) through auctions of three- to eight-year bonds, matching the upper end of their target — though given how active dealers tend to be in these sales, the results may not necessary sound the all clear.

Stretched Finances

The election battle is shining a spotlight on the country’s already stretched finances. Without further measures to control the budget, the International Monetary Fund said debt would rise to 112% of economic output in 2024 and increase by about 1.5 percentage points a year over the medium-term.

The European Union reprimanded France on Wednesday for running a deficit that exceeds the bloc’s 3% limit, and S&P Global Ratings downgraded its sovereign credit score just last month. 

“The fiscal situation is not great,” said Robert Dishner senior portfolio manager at Neuberger Bermam.

French Bond Rout Upends Hierarchy in Europe’s Debt Markets (1)

Still, the French-German spread settling around current levels is not necessarily cause for panic, according to Salman Ahmed, the macro and strategic asset allocation global head at Fidelity International.

“The market is pricing in more risk premium but we’re not expecting a full blown sovereign crisis,” Ahmed said on Bloomberg TV. “The France-German spread at 120 basis points would be concerning, we’re some way from that.”

Others anticipate the widening momentum is far from over. Federated Hermes forecasts the yield-gap will rise 90 basis points heading into the election, while Capital Economics says 100 basis points could be the new normal.

“There could still be quite a lot of volatility,” said Chris Iggo, the chief investment officer at AXA Investment Managers. “It’s difficult to see the spread go back to where it was three or four weeks ago.”

--With assistance from Sujata Rao, Naomi Tajitsu and James Hirai.

(Updates market pricing, chart.)

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