France’s economy could remain trapped in a prolonged period of weak domestic demand, subdued inflation and difficult fiscal adjustment, as structural changes in its labour market leave it more exposed to high interest rates than its euro zone peers, according to Citi Research.
In a note published on Friday, Citi argued that France’s economic weakness is not simply cyclical but reflects a deeper shift that has left the economy "underpressurised" relative to the rest of the currency bloc.
While headline growth has broadly kept pace with recent euro zone trends, domestic demand has lagged and inflation has consistently undershot the bloc’s average.
Inflation excluding tobacco has run around 1.2 percentage points below the euro area average over the past year, with the gap particularly evident in services, a sector closely tied to labour market conditions.
Citi economist Michel Nies said the weakness stems partly from an improvement in France’s labour market over the past decade. Reforms and other structural changes appear to have lowered the economy’s equilibrium unemployment rate, creating more spare capacity than is commonly recognised.
As a result, unemployment fell sharply before and after the pandemic without generating the wage pressures normally associated with a tight labour market.
That left France especially vulnerable when the European Central Bank began raising interest rates in 2022.
With inflation lower than elsewhere in the monetary union, French households and businesses have faced comparatively higher real borrowing costs, weighing on spending and investment.
Household deleveraging has amplified the trend. Annual household credit flows averaged 2.4% of GDP between 2013 and 2019 but slowed to just 0.4% between 2023 and 2025, while savings rates increased more sharply than elsewhere in the euro area.
Citi estimates the contribution of domestic demand to economic growth has roughly halved since before the pandemic, largely because of weaker consumer spending and housing investment.
The bank describes the process as a form of "internal devaluation" in which competitiveness improves through lower wage and price growth relative to trading partners rather than through currency depreciation.
Such adjustments have historically helped economies improve competitiveness and external balances, but often at the cost of years of subdued domestic activity.
France’s fiscal position leaves policymakers with limited room to offset that weakness. Public debt remains elevated and markets have become increasingly sensitive to the country’s budget trajectory.
According to Citi, weaker nominal growth could significantly complicate efforts to stabilise debt levels. If growth remains subdued while borrowing costs rise, France would need far tighter fiscal policy to prevent debt from increasing further.
Despite the near-term challenges, Citi sees some signs that the adjustment is beginning to bear fruit. Net exports have improved, productivity growth has recovered and overall GDP growth has held up better than weak domestic demand alone would suggest.
France could also benefit from rising European spending on defence, aerospace and strategic technologies, sectors where it enjoys competitive advantages.
Still, Citi cautioned that the process is likely to be lengthy. Drawing comparisons with Germany’s labour market reforms and southern Europe’s post-crisis adjustments, the bank said similar rebalancing efforts have historically taken years to deliver their full benefits.
source https://www.investing.com/news/economy-news/france-faces-economic-slack-as-structural-shifts-weigh-on-demand-citi-4751681
