Scenario Eco - Excessive imbalances

Scenario Eco – Societe Generale
Michala Marcussen, Societe Generale group Chief Economist
September 2025
Excessive imbalances

Will France secure budget deficit reduction?
Challenges in securing the French 2026 budget were largely priced by financial markets in the already elevated yield spreads over Germany. Avoiding further spread widening, and the resulting damage to economic growth and employment, however, requires that the French government ensures a downward trajectory for the budget deficit, which today is one of the largest in Europe. We consider a pathway where France choses to breach the European Fiscal Framework, and risk losing the protection offered by the ECB’s Transmission Protection Instrument to be a low probability tail risk.
Political uncertainty is, however, set to remain elevated not least in the countdown to the 2027 Presidential elections.
Is there a risk of fiscal dominance?
Yield curves have steepened across major markets driven with fears of fiscal dominance, and not least in the US, marking a major contribution. Fiscal dominance arises when a government successfully pressures the central bank to accommodate large budget deficit by delivering low interest rates and/or purchasing government debt to compress term premia. Ultimately this can trigger stagflation as many episodes in history show.
Our forecasts assume that the major central banks will retain independence, but concerns of burgeoning public debts and geoeconomic fragmentation, also adding inflation risks, is likely to see structurally steeper yield curves.
With so much uncertainty, why is growth proving resilient?
Ironically, some sources of uncertainty may initially contribute to growth not least through front loading behaviours. We saw this on global exports ahead of the various rounds of US tariffs, with US importers front loading orders and building inventories. Such front-loading, however, usually comes with payback further down the road and some of this payback is already materialising.
Faced with uncertainty, corporates will typically delay investment and hiring decisions, seek to protect margins by avoiding price cuts and look to build cash balances. In the first round, corporates will often avoid layoffs, least the uncertainty does not materialise. Faced with lasting uncertainty, and ever more prudent households, corporates will ultimately cut staff.
Recent employment data suggest that the US is reaching an inflection point where significant layoffs may now follow, and our concern remains that a more substantial slowdown is about to unfold. It is worth note, moreover, that weaker labour supply due not least to weaker immigration, has helped keep the unemployment rate low even as job creation has slowed. Here too we see an inflection point an expect US unemployment to move higher over the coming quarters, opening up to more Fed rate cuts.
Will the ECB cut further?
Euro area inflation is back close to target and with growth still proving fairly resilient, the ECB is clearly in wait-and-see mode. To our minds, an additional rate cut could still be on the cards to take out some downside insurance.
An additional important question for the ECB is when to slow the quantitative tightening that so far has been leaning against the rate cuts. To our minds, with rate cuts largely done now would be a good time to taper quantitative tightening.