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France's Hollande 'in denial' over crisis after downgrade

Fred Dufour | AFP | Getty Images

The French president Francois Hollande appeared the eternal optimist on Sunday when he told the nation that France was "in recovery" despite economic evidence to the contrary, prompting analysts to say Hollande was refusing to face up to the country's economic reality.

"Hollande is in denial over the state of the French economy," Michael Hewson, senior market analyst at CMC Markets, told CNBC on Monday. "He points to the slight improvement in economic data last month as evidence that the French economy is improving when deep structural problems remain. To my mind this points to a president who is hoping that something will turn up, and that isn't a policy."

Hollande used Bastille Day, France's national commemoration of the French Revolution in 1789, to argue that Europe's second-largest economy was recovering and tried to fight increasing pessimism over France's economy after Fitch ratings agency stripped France of its last AAA rating last Friday. The yield on France's benchmark ten-year bond was barely changed on Monday morning at 2.18 percent.

(Read More: France's Hollande: The Euro Zone Crisis Is Over)

Hollande vowed to "fight" national pessimism over the economy and insisted that "the economic recovery is here." He cited data showing that domestic consumption and industrial production were increasing during the televised interview with the France 2 TV network.

In fact, the official INSEE statistics agency said last week that French industrial output fell 0.4 percent in May from April as production of manufactured goods dropped. Unemployment, meanwhile, remains at a 14-year high, rising to 10.8 percent in the first quarter of 2013 from 10.5 percent in the fourth quarter of 2012.

France's economy contracted by 0.2 percent in the first quarter of 2013, INSEE reported in June, confirming fears that the country had entered recession.

Last week the Bank of France forecast growth of 0.2 percent in the second quarter and, despite Hollande's upbeat forecast, predicted that unemployment would increase, domestic demand would remain "sluggish" over 2013 and that household consumption would "slip again in 2013."

Economist Chris Scicluna, head of economic reserach at Daiwa Capital Markets, told CNBC that while it was "over-doing it" for Hollande to herald a French recovery, French economic conditions were "clearly far superior to those in Portugal, Italy and Spain, for example." Senior European economist at Capital Economics, Jennifer McKeown, agreed, saying it was "optimistic to say the least to say that France's economy is in recovery" with consumer confidence so very low.

"Hollande is in a very bad position given that a year into his government he has been unable to implement any meaningful reforms, "she told CNBC on Monday. "He's just being very hopeful to say there's a recovery. I wouldn't be surprised if France remained in recession in the second quarter, the Bank of France tends to err on the optimistic side and, like all of us, can get forecasts wrong."

Hollande, whose approval ratings ebbed to an all-time low in a June poll, did not rule out tax increases and more budget cuts on Sunday as his government struggles to rein in the budget deficit.

(Read More: France Likely to Miss Deficit Target, Auditors Warn)

"We will make — we have made — savings, and I will increase taxes only if absolutely necessary, ideally as little as possible," he said, playing down his lack of public approval by adding that he was "not looking to be popular." Just 26 percent of the French population is now satisfied with his performance.

(Read More: France in 'FreeFall' as Fund Managers Short Bonds)

Analyst Hewson was not convinced that Hollande could implement reforms.

"His comments that spending cuts would be implemented at a rate compatible with growth suggest that he will continue to struggle to do what is necessary with the French economy given the vested interests pulling him in different directions. The fact is with the state accounting for over 50 percent of GDP he needs to do more than tinker around the edges and talk about cuts."

When Fitch, which is part French-owned, stripped France of its last top-notch credit rating it cited "deepening political, financial, and monetary problems within the euro zone, with which France is closely integrated" as a reason for the downgrade.

One strategist said the downgrade should spur France's political establishment into action but said France's borrowing costs, which have experienced what one economist called an "uneasy calm" recently, would be little moved.

"Credit rating downgrades, particularly of sovereigns deemed to be relatively safe, have been of scant significance to investors for quite some time… However, if there's one country in which a downgrade ought to be a wake-up call for politicians to step up the pace of fiscal and structural reforms, it's France," Nicholas Spiro, head of Spiro Sovereign Strategy, said. France holds a bond auction at 13:50 p.m. London time where it plans to sell up to 7.5 billion euros in short-term paper.

"It's a reminder, if one were needed, of the breadth and depth of the euro zone crisis. Although France has been trading like a core euro zone credit pretty much throughout the crisis, its weak economic fundamentals have long belied its low borrowing costs. In some ways, France has been the 'lucky peripheral'," Spiro said.

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt

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