In Summary
With elections ahead in France, Spain, Greece, and Italy in 2027, political risk will be at the center of European government bond markets. Our high-frequency Political Fragility Index (PFI) shows that Europe is at a peak level of political fragility. Our PFI, is built on polling data across four drivers — fragmentation, disaffection, polarization and governability. The Netherlands and Belgium sit high on fragmentation (votes splintered across a rising number of smaller parties), while France tops the list on polarization (rising voting share for far-left, far-right, Eurosceptic and populist parties). Germany and the UK show the sharpest increases in fragility since 2020 both suffering from weakening governability.
Sovereign risk premia (defined as asset swap spreads or ASW) have never been more sensitive to political fragility, and institutions matter more than the level of fragility. The effect of political fragility on risk premia is a one-way ratchet: once triggered, it stays in the equation even after the trigger fades. This link, latent under QE, is now structural, with sensitivity at a record high (+1 std. dev. in the PFI adds +53bps to Italy's ASW). The risk premium is purely fiscal. Note that despite rising Eurosceptic votes, markets have priced out redenomination or euro breakup risk.Institutionally, majoritarian systems (UK and France) carry more political tail risk than their fundamentals imply for a given rating. This argues for a wider hedge around their electoral and budget calendar, while risk premia from consensus system issuers (e.g. Netherlands) tend to stay anchored through political noise.
To date, and since the end of QE in 2022, political fragility has resulted in an additional interest expense of around EUR 98bn (partly paid and partly still to be paid), when we sum up Italy, France, Spain, Belgium and the UK. On average, this represents an extra 3% of their annual debt servicing costs past and future. This burden is concentrated in the UK (EUR 41bn which represents roughly 2.8% of additional debt service costs per annum over the maturity of the debt) and Italy (EUR 41bn; 4.9%), followed by Spain (EUR 14bn; 4.5%) and France (EUR 11bn; 2.3%). In France's case, most of this additional cost stems from the dissolution of parliament in 2024. Safe haven countries like Germany, the Netherlands and Austria show no structural fragility premium yet. Their shift from a negative to a positive ASW was mainly driven by a repricing of their fiscal fundamentals. However, given their underlying fragility this could change quickly, a structural fragility premium could add 1-2% to annual interest expenditure. Portugal and Greece were excluded given their bailout-distorted financing conditions.
France's presidential elections (April 18 and May 2, 2027), followed by Italy's general election due by 2027, are the next big rendezvous between political fragility and the bond market. Our PFI shows France's sovereign premia are structurally sensitive to political fragility (+1 std. dev. adds +38bps to the ASW). This channel may keep pushing the OAT-Bund spread toward 90bps by year-end, with normalization contingent on a parliamentary majority in June 2027. In Italy, fragility is the single most sensitive channel in our sample (see supra) but it is currently dormant. Our baseline holds the BTP-Bund spread near 80bps, though a Eurosceptic turn on either flank, amplified by the proposed majoritarian electoral reform, is a fatter tail that could reawaken the redenomination premium France's spread no longer carries.