French borrowing costs jump on Macron wage rises, tax cuts

By Abhinav Ramnarayan

LONDON (Reuters) - France's 10-year borrowing costs climbed to their highest level compared with Germany's in a year and a half on Tuesday, as President Emmanuel Macron announced spending measures after weeks of violent protests.

Macron announced wage rises for the poorest workers and tax cuts for pensioners late on Monday, which are expected to increase public spending by 8-10 billion euros.

France's 10-year bond yield rose by as much as five basis points to 0.756 percent on Tuesday, before easing to around 0.71 percent. The spread over equivalent German bonds hit 47.5 basis points, its widest level since May 2017.

"The measures suggest there will be more spending from the French government, which implies a higher deficit in 2019 and weakens the financial position," said Commerzbank rates strategist Rainer Guntermann.

"French newspapers are suggesting this morning that we could have a 3.5 percent deficit in France in 2019, which complicates the discussion in the euro area and gives other countries such as Italy an argument for a higher deficit."

The French budget minister said on Tuesday the government now expected a 2019 budget deficit of 2.5 percent of economic output, excluding the one-off impact of transforming a payroll tax rebate into a permanent cut.

As the overall deficit was previously expected to be 2.8 percent, the new underlying deficit risks pushing the overall number towards 3.4 percent - past the European Union's 3-percent limit.

"The moves in France are negative for the budget deficit and not a good demonstration effect for Italy as whole," said Rabobank rate strategist Lyn Graham-Taylor.

The European Commission earlier this year rejected Italy's draft budget, which envisaged a deficit of 2.4 percent of GDP in 2019, up from 1.8 percent this year.

The European Commission is willing to accept an increase in Italy's deficit target to 1.95 percent for next year, the newspaper La Repubblica said on Tuesday.

Italy's 10-year government bond yields were up three basis points at 3.12 percent on Tuesday. The spread over Germany widened to 287 bps.

Higher-rated euro zone bond yields fell in late trade on further signs of turbulence in Britain.

Some lawmakers in Prime Minister Theresa May's Conservative Party are confident that enough letters of no confidence have been submitted to trigger a leadership challenge, the deputy political editor of Sky News said.

That news pushed German Bund yields down to 0.224 percent - matching six-month lows hit last week.

But the Brexit uncertainty weighed on Irish bonds. The gap between 10-year Irish yields and those in benchmark Germany hit its widest in six months at 68 basis points.

(Reporting by Abhinav Ramnarayan and Dhara Ranasinghe; editing by Andrew Roche)