French President Emmanuel Macron announced tax cuts and wage rises on Monday in a bid to placate anti-government protesters, but the move will increase France's budget deficit and is likely to create tensions with the European Commission.
Macron promised on Monday to raise the minimum wage by 100 euros ($114) a month and that overtime will not be taxed or subject to social welfare charges. He also said the tax hike on pensions will be reversed for anyone with an income of below 2,000 euros a month, and encouraged companies to pay a tax-free end-of-year bonus.
France has been wracked by four weeks of civil unrest and anti-government protests by yellow-jacketed protesters. The demonstrations started in response to planned fuel tax increases but morphed into wider anti-establishment, and particularly anti-Macron, protests and riots.
The French government initially responded by delaying and then cancelling the planned fuel tax rises but protesters were not placated by the move and unrest continued last weekend.
In a televised address Monday after scenes of havoc in Paris on Saturday, Macron said he bore partial responsibility for what he said was an insufficient response to souring public sentiment.
"At first it was anger against tax and the prime minister responded by cancelling and removing all rises planned for the start of the new year. But this anger is deeper. I feel it is fair in many ways," he said. "I may have given you the impression that I didn't care, that I had other priorities. I know I may have upset some of you with my words."
Macron's promises might be a balm to some protesters, but economists note that they come at a cost. France's borrowing costs rose on Tuesday with the spread between France and German ten-year bonds - seen as an indicator of risk sentiment - the widest since May 2017. The yield on France's 10-year bond rose five basis points to 0.756 percent Tuesday before declining to 0.726 percent.
Macron's pledges are likely to get France into trouble with the European Commission for raising its budget deficit, the amount by which its spending exceeds its revenues, above the permitted limit of 2 percent of GDP. Macron's announcement could also be a gift to Italy, given its own wrangling with the Commission over its spending plans for 2019.
"Macron's sweeteners are coming at a cost," Berenberg Economists Kallum Pickering and Florian Hense said in a research note Tuesday.
"They add up to 10 billion euros or slightly more, equivalent to 0.4 percent of gross domestic product (GDP). On top of the already announced 4 billion to cancel the fuel tax hike, this could push the 2019 deficit from 2.8 percent to 3.4 percent of GDP unless offset by savings, which will be difficult to find," they noted. France's debt-to-GDP will likely rise beyond 100 percent as a result of the concessions too.
Italy is likely to watch the European Commission's response to France very closely given that it is in an ongoing dispute with the EU's executive body about its own 2019 budget.
Italy is in trouble with the commission because it is planning on spending more than it previously promised, bringing about a budget deficit of 2.4 percent. EU rules state that member countries should work to bring down their deficits and debt piles.
Berenberg's Pickering and Hense noted that the concessions "could also complicate the current conflict between the EU and Italy."
"The key difference, though, is that France is cutting taxes and spending some money to get pro-growth supply-side reforms through. Italy is spending more money to do exactly the opposite."
IMG Chief Economist Robert Carnell said in a note Tuesday that Italy will be the country that's "most interested in the impact on the French deficit" and that any inconsistency in the treatment of Italy and France could be seized upon.
"Of course, deficit procedures are more complicated than a straight comparison of deficits, but to the average yellow-vested punter on the streets, this is about as far as it usually gets," he said.
"For all those looking for a euro rally next year, this sort of internal European inconsistency, as much as the mediocre macro story, provides a good reason to keep EUR expectations limited.