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French bonds steady on optimism of avoiding snap election

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Macron to name new PM by Friday evening

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France-Germany bond yield spread remains elevated

(Updates for European morning trading)

By Samuel Indyk

LONDON, Oct 9 (Reuters) - French bonds on Thursday held

on to gains from the day before on optimism the country can

avoid a snap election and agree a budget, after talks between

caretaker Prime Minister Sebastien Lecornu and other political

leaders.

Lecornu resigned on Monday after failing to reach

compromises with other parties on fixing the country's shaky

finances, and was tasked by President Emmanuel Macron with

defusing the crisis.

Macron said on Wednesday that a new prime minister would be

named within 48 hours and that most lawmakers were against snap

elections, but investors remain wary about France's ballooning

budget deficit.

"If there is not a credible path to rein in the deficit,

then it suggests France will continue to have the same problems

for the foreseeable future," said Salomon Fiedler, economist at

Berenberg.

SHORT-TERM RELIEF FOR MARKETS

France's 10-year bond yield was little-changed

on the day at 3.511%, after falling 5.5 basis points (bps) the

day before on optimism that a deal to avoid new elections could

be reached. It rose 6 bps on Monday after Lecornu's resignation.

Bond yields move inversely to prices.

Germany's 10-year bond yield, the benchmark for

the euro area, was up 1.5 bps to 2.691%, pushing the spread

between France and Germany's 10-year yields to 81.5 bps, down

from nearly 88 bps on Monday.

The gap premium investors require to lend to France rather

than Germany remains elevated and is among the highest in the

euro zone.

"Whilst we understand that avoidance of fresh elections will

be a relief for markets, it is hard to see a budget that does

little to tackle fiscal sustainability being a massive spread

tightener over the medium term," RBC Capital Markets analysts

said in a note.

POLITICS ASIDE

Away from politics, focus on Thursday was the European

Central Bank's accounts from their September meeting.

The ECB kept rates unchanged last month and dampened

expectations for future rate cuts, saying the economy was in a

"good place".

"They will probably be on hold this year and next year as

well," Berenberg's Fiedler said.

"I don't think they'll react to any of the French turbulence

that we see now."

Futures imply just a 10% probability of a rate cut by

year-end.

Germany's two-year yield, which is sensitive to

alterations in interest rate expectations, was little changed at

1.992%.