LONDON, Aug 30 (Reuters) - France's financial assets are stuck in a rut as a political stalemate and policy paralysis take hold, casting a shadow over the outlook for markets and deteriorating public finances.

Investors hoping to snap up stocks and bonds battered by President Emmanuel Macron's decision in June to call a surprise election may have a long wait.

The election delivered a hung parliament and weeks later France still has only a caretaker prime minister. Macron has slammed the door on a possible leftist government, despite the left bloc winning the most seats in July's second-round vote.

Meanwhile, Paris and Brussels remain at loggerheads over France's worsening fiscal situation, and prolonged political uncertainty and possible delay to next year's budget could push back any market recovery.

"Potentially, you have the capacity for French politics to look a bit bumpy again over the next few months," said Mark Dowding, chief investment officer at BlueBay Asset Management.

Here's a look at how French assets are faring and what's next:

1/ STUCK IN THE MUD

France's weak fiscal position looks set to keep government bonds on the back foot.

The risk premium, or spread, demanded by holders of French debt over safer German bonds is around 71 basis points (bps). That's higher than the 50 bps seen before the election, but down from 85 bps reached in late June - the highest since the euro zone debt crisis over a decade ago.

An S&P sovereign rating downgrade in May and a warning from Moody's in July suggest French borrowing costs will remain relatively high for now.

France's debt as a share of its gross domestic product stands at over 100%. Germany's stands at just over 60%.

"We think this will be a gradual move wider over time, in-as-much as we think that any move in spreads will be capped below 100 bps, beside a presidential election taking place," BlueBay's Dowding said, referring to the French/German bond gap.

2/ STABILITY, WHERE ARE YOU?

French equities have underperformed European counterparts since Macron's June 9 election announcement and an initial post-election relief rally fizzled out.

A rebound will remain elusive until the political deadlock breaks, analysts said.

The blue-chip CAC 40 (.FCHI) , opens new tab index is 4.6% below levels seen in early June, while Germany's DAX (.GDAXI) , opens new tab is up 2% and the broader European STOXX 600 (.STOXX) , opens new tab is little changed. French mid-caps (.CACMD) , opens new tab, with greater exposure to the domestic economy, are down 8%.

"Markets maybe underestimated how difficult the political situation is," said Morningstar European equity strategist Michael Field.

"Until we see signs of what a government will look like, and more importantly whether it is strong enough to last the distance, we're probably unlikely to see a recovery in equities."

Data from Morningstar Direct showed an estimated 243 billion euro ($270 billion) outflow from French equity and small- and mid-cap funds in June, which has failed to materially recover.

3/ MONEY IN THE BANK

French banks have been hit particularly hard, but for some that's also a buying opportunity.

Societe Generale (SOGN.PA) , opens new tab, BNP Paribas (BNPP.PA) , opens new tab and Credit Agricole (CAGR.PA) , opens new tab - the big three French banks - are down between 5% and 16% since the June election decision. Europe's bank index is down just 0.6% over the same period (.SX7P) , opens new tab.

Morningstar's Field said the international exposure of the big French banks was a buying opportunity. He also warned that prolonged political uncertainty could hurt, while the risks of a widening deficit under a leftist government could spark rising funding costs.

"I can certainly see the negatives around banks, but where there is disconnect is around how exposed some banks are," he said.

"BNP and SocGen are our favoured plays and they're diversified enough away from that domestic market with their funding being more international, that they can ride through that."

4/ WHAT CRISIS?

The euro , which took a brief knock in June, has bounced back and is unperturbed by France's political woes.

It hit a 13-month high against a broadly weak dollar earlier this week, with currency traders' focus on the outlook for interest rates.

The U.S. Federal Reserve is expected to embark on a series of rate cuts, with the European Central Bank going slower on monetary easing - a positive outcome for the euro.

"Political uncertainty might weigh, even in the case of a non-leftist government, but more to limit more euro strength rather than triggering a sell-off," said UniCredit currency strategist Roberto Mialich.

($1 = 0.9015 euros)

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https://www.reuters.com/markets/europe/frances-political-quagmire-keeps-asset-recovery-bay-2024-08-30/