As interest rates go up globally, Western European welfare states that have been resisting material reform for decades are feeling the pinch. Most prominently France is in the spotlight here. The spread between French and German government debt is sharply increasing, also due to suggestions by the French far left that they may well default on the state’s obligations, when in power.
The French government is meanwhile trying to introduce some savings, but markets are not convinced, even demanding higher interest rates on French than on Italian debt.
On 8 October, ECB President Lagarde already issued the first verbal intervention to cap French yields. Asked at a closed-door meeting in Luxembourg with Eurozone Finance Minister about sovereign spreads, she reportedly reiterated the ECB’s position that the institution is attentive to the good functioning of financial markets, “people familiar with the talks, who spoke on the condition of anonymity” told Bloomberg. She thereby reportedly added that the ECB has instruments to counter unwarranted, disorderly market dynamics that threaten the smooth transmission of monetary policy, subject to clear eligibility criteria.
Commenting on the situation, Robin Brooks, a senior Fellow at the Brookings Institution and a previous Chief Economist at the Institute of International Finance, says: “The situation is serious. The doom loop – the link between banks and sovereigns – is as bad as it was in 2011/12. If yields keep rising, we’re back to deposit flight.”
One of the options the ECB has is to activate its so-called Transmission Protection Instrument (“TPI”) programme, to “counter unwarranted, disorderly market dynamics” that threaten the transmission of monetary policy. As Bloomberg explains, this means that “the central bank would effectively print money and use it to buy up bonds being dumped by investors. There would be no preset spending limit, and some aspects of the TPI have been deliberately left vague so the central bank could react flexibly to whatever crisis it might be facing.”
This has never been used, and neither has another ECB programme, the Outright Monetary Transactions (OMT) plan, an ECB bond-buying programme created in 2012 that comes with more stringent conditions than TPI, for example that the country being propped up is part of a European rescue program with policy conditions.
As Brooks and many others have explained before, the ECB has really been propping up shaky Eurozone welfare states for years, through all kinds of policies. At the end of the day, everything will depend on Germany’s tolerance for these kinds of back-door transfers to other European countries. On the sidelines, there is also the fact that, despite her denials, Lagarde is still being named as a potential participant in France’s 2027 Presidential election while at the same time chairing the institution that has great influence on France’s economic fate. This should raise eyebrows and may not be helpful for the ECB’s credibility as a politically neutral institution.
French yields have completely decoupled from the rest of the world. Chart shows the rise in 10-year gov't bond yields above and beyond the global average. France is now in a league of its own and has morphed into an idiosyncratic risk factor for markets…https://t.co/HIlymWt6U2 pic.twitter.com/H3Xk83WlTF
— Robin Brooks (@robin_j_brooks) October 13, 2026
Proposals for more EU spending under fire
France’s woes are not yet having an effect on the long term EU budget negotiations. Despite being a net payer into the EU budget, and despite its budgetary woes, France has declined to join the group of six EU member states – Germany, the Netherlands, Austria, Denmark, Sweden and Finland – that are demanding “several hundred billion euros” in cuts to the draft to the next EU 2028-2034 budget. It should be noted that this would still allow EU spending to be higher than during the current 2021-2027 budget period.
A specific problem here is the high interest burden for the EU’s wasteful and fraud-sensitive Covid recovery fund, which represents a millstone around the neck of the EU budget. Unlike regular EU spending, this has been funded by jointly issued EU debt, which will now need to be repaid.
Two years ago, the Dutch EU ambassador commented on this burden, saying: “It hangs over our heads like the sword of Damocles. Budgeting means looking ahead. (…) The Netherlands is cutting 20 percent of civil servants. That is not easy. But if we can do it, why can’t we discuss it here?”
Diplomats are now trying to get a deal on the next Multiannual Financial Framework (MFF) by the end of the year, but according to leaked German diplomatic cables, “EU capitals are hopelessly deadlocked”, Politico reveals. According to the 22 September cable, “no potential areas for compromise were apparent” during a recent meeting of Europe ministers.
Interestingly, the German diplomatic cable reveals that Germany, the Netherlands, Austria, Denmark, Finland, Sweden and Belgium “emphasized the need for significant cuts,” while France was merely “open to targeted cuts.” France was also among the member states that said that “cuts in the areas of agriculture and cohesion are out of the question.” A new compromise proposal submitted by the Irish EU Presidency has failed to change much. It was immediately shot down by the group around Germany.
German Chancellor Friedrich Merz and five other EU leaders have threatened to withhold agreement on the bloc’s next seven-year budget unless 'hundreds of billions' of euros in spending cuts are secured https://t.co/gATOMhvdov pic.twitter.com/IjowUbDq5L
— Financial Times (@FT) September 29, 2026
Opposition to more EU taxes
As an alternative to savings, the French government has been pushing instead for new EU “own resources” – EU taxes in name only. It wants these to raise 60 billion euro. Reportedly, there is quite some support among EU governments to expand the use of these “own resources”, until the specifics are discussed. The Irish EU Council presidency has stated there is “consensus” among EU governments to use income from the Carbon Border Adjustment Mechanism (CBAM), a new EU climate tariff, and from a new electronic waste levy, to finance the new long term EU budget.
Other proposed “own resources” remain controversial however. Proposals to introduce levies targeting tobacco products, corporate turnover or revenues from the Emissions Trading Scheme are reportedly facing opposition from several countries, with for example Sweden also being concerned about the impact on snus, which is popular in the country, which enjoys an exemption from the EU ban on it. Its popularity goes hand in hand with much lower smoking rates and much lower rates of correlated diseases. Ignoring the different health impacts of various products is indeed not a good idea from a public health perspective.
Still, that most certainly is what the European Commission has been doing, also in related policy discussions; for example with the Commission’s proposal to sharply increase tobacco and nicotine excises. Also here, Swedish resistance is fierce. The decision has been postponed until November, to allow extra time for Sweden to form a new government after its recent national election. Coalition talks are however going very difficult in Sweden at the moment.
In any case, the “frugal” member states have become a lot more vocal. In a letter, the six member states point out that the “own resources” discussion clouds the debate. They state: “The EU budget is ultimately paid for by European citizens. That remains true whatever financing mechanism or own resources we invent.”
The “frugal six” also seem relaxed about not reaching a deal this year. A diplomat from one of the signatory countries is cited by the FT saying: “Unless the budget is cut by hundreds of billions, there won’t be an agreement this year.” This was echoed by Austria’s EU Affairs Minister, Claudia Bauer, who called the deadline “artificial”.
Telling thereby is also that the European Parliament “won’t even have a Parliament position by the end of next year if we continue at the same pace”, according to MEP Damian Boeselager, one of the Greens’ negotiators on the budget. In past negotiation rounds on the long term EU budget, the European Parliament always came up with demands for EU spending that were even bigger than the European Commission’s. Thanks to the increased voting share of the right, that appears to change now.
The clock is ticking. In 2027, there will be elections in France, Italy, Spain and Poland that may threaten to derail talks and delay payouts. In France, Marine Le Pen’s National Rally has pledged to halve Paris’s contribution to the EU budget. Some recent opinion polls project her as the winner against every possible opponent in the second round.
Poll shows French far-right leader Marine Le Pen widening lead ahead of 2027 presidential vote
➡️ https://t.co/KlUSjVJ9eI pic.twitter.com/nFw7T822nO— FRANCE 24 English (@France24_en) September 28, 2026
Resistance to EU regulation
The push for greater fiscal restraint also comes amid growing demands for Brussels to tone down its regulatory ambitions. In September, 13 EU member states, led by Austria, demanded a round of ‘deep cleaning’ of EU legislation. They thereby called for a “European Implementation and Consolidation Year, primarily focusing on implementation of existing legislation, simplification, interoperability, evaluation of cumulative burden, enforcement convergence, reduction of duplicative reporting obligations, and indispensable legislative amendments.”
The initiative raises an obvious question: Why should Brussels continue adding regulatory costs while member states demand greater fiscal discipline? A genuine year of simplification should also scrutinise the EU’s expanding legislative pipeline, including the Circular Economy Act, European Product Act, Digital Fairness Act and the planned review of the Tobacco Products Directive, to ensure new rules do not further undermine European competitiveness.
This is particularly relevant given the debate about the EU’s economic challenges from China. German Chancellor Friedrich Merz and French President Emmanuel Macron recently called for stronger EU trade defence mechanisms to address Chinese market distortions. Meanwhile, the influx of illegal and counterfeit goods, including electronics, textiles and e-cigarettes, remains a growing concern, with EU anti-fraud body OLAF highlighting the role of Chinese imports.
In contrast to the alarmism about the role of China, the EU has been less willing to confront how its own regulatory environment weakens European industry. Stronger enforcement against unfair trade practices and illegal imports is necessary, but it will accomplish little if European businesses continue facing rising compliance costs, regulatory uncertainty and additional taxes. Protecting European competitiveness also means addressing the burdens the EU places on its own industries.
Conclusion
As Western European welfare states are coming under strain, with France at the heart of it all, talk of a new Eurocrisis has rekindled. The fiscal pressures are bound to complicate a deal on long term EU spending even more than it would have been, as the EU’s overregulation continues to be challenged by those who realise it is at the heart of the lack of competitiveness which is causing low economic growth and thereby insufficient tax income. The road is still long, but surely but steadily, the economic policy consensus in Europe is shifting.
