06:50 AM EDT, 10/02/2024 (MT Newswires) -- The euro weakened on Tuesday mainly due to the broader US dollar rally and increased risk aversion caused by the widening conflict in the Middle East. But investors did have a much-anticipated 90-minute speech from French Prime Minister Michel Barnier that provided markets with some initial detail over the plans for bringing the French budget back under control, said Mitsubishi UFG.

Barnier announced a two-year extension to 2029 to get the deficit back to the 3% European Union limit. This will allow Barnier to present a budget that isn't as "aggressive" in cutting the budget deficit and will as such be more likely to get approved by parliament, wrote the bank in a note to clients.

The projection now is to reduce the budget deficit from over 6% this year to 5% next year. Two-thirds of this decline will come from spending cuts and the rest from tax increases on wealthy individuals and companies recording "significant profits."

The mix of ways to get the budget down, skewed toward spending cuts, will anger the left but will be more palatable for the right and for far-rightist RN specifically. RN is the largest single party in parliament and as such it makes sense to lean more toward garnering its support, stated MUFG.

The left is likely to oppose the budget and attempt to bring down the government but RN's Marine Le Pen has suggested her party wouldn't support such a motion providing scope for the government to get a budget approved. This makes sense and RN's ultimate goal is likely to show the country that the parliament of France can function without collapse when RN is the largest single political party.

The biggest prize of all is the presidency in 2027 and that involves strengthening the credibility of RN which gives the chance of progress with a budget. Le Pen thanked PM Barnier for the "respect" shown and promised time for the government to function. Barnier in his speech also promised to tighten immigration controls.

The full details of the budget will be revealed next week, but the prospects of getting something approved look a little better than before the Barnier speech and this is reflected in the modest narrowing of the OAT/Bund spread from 80bps to 78bps, added the bank.

If the spread does remain contained through the budget process next week, it will remove one near-term downside risk for the euro, according to MUFG.