Short Update on France

France reported better than expected business confidence figures today. The March reading of 96 compares with Feb's 93 and is the first time in over a year that business confidence has improved two consecutive months.

Yesterday's disappointing flash PMI report (mfg 47.6 vs 50.0 in Feb and service unch at 50.0 vs expectations for a small increase) overshadowed news that the French government revised its forecast for 2012 growth to 0.7% from 0.5%. Some dismissed this as politically motivated as President Sarkozy continues to trail in the polls, the first round of which is a month away.

The latest poll (BVA) shows Hollande beating Sarkozy in the first round 29.5% to 28% and, more tellingly in the second round 54% to 46%. Sarkozy has moved right--with promises of reform of the voting system and referendums on divisive issues and a tougher line on immigration.

Hollande for his part appears tacking to the left where the further leftist candidate is drawing 10-11% in the first round. Still, Hollande's tax and spend proposals stand out against the mainstream of the European political and economic elite.

The government's more optimistic economic forecasts cuts two ways. On one hand, avoiding a recession is a good thing. On the other hand, unlike say the Netherlands, as a core country that is expected to contract this year, and is struggling to make its deficit target, France would seem to have less of an excuse.

The structural budget deficit is bigger now than at the beginning of Sarkozy's term. The use of "structural" here is key. This is an assessment of what the deficit would be if France was growing at trend. While the government anticipates the structural deficit fall by 1.25% this year, if achieved it would still leave a 3.25% structural deficit next year. Under the terms of the new fiscal compact, this has to be reduced to 0.5%.

The premium France pays over Germany (10-year benchmark) has narrowed 20 bp here in Q1 to 111 bp. While this is down from peak of 190 bp last November, it remains elevated compared with any other time under the conditions of monetary union. The spread now shows resistance to move back below 100 bp.

While the LTROs were a dominate driver in Q1, the focus in the quarter ahead will be French politics and whether the economy can avoid a new contraction, which would likely require more savings to reach the deficit target.