• French bonds under pressure, risk premium highest since euro zone debt crisis
• Stocks also underperforming as political uncertainty premium remains
• French bank shares remain below levels before Macron called snap election

LONDON, Sept 27 (Reuters) - France finally has a new government, but it is unclear how long it will survive, so the political uncertainty hanging over French financial markets is unlikely to lift anytime soon.

The right-leaning cabinet, appointed 2-1/2 months after an inconclusive snap election, has a tough task ahead to get reforms or the 2025 budget approved by a very divided parliament.

"It's the question mark: How long will that government continue?," said Michael Krautzberger, chief investment officer for fixed income at Allianz Global Investors.

With investor unease rising again, we look at how French assets are faring and what's next:

1/ BONDS BRUISED

France's government bonds are under renewed pressure.

Their closely watched risk premium over German debt is trading around 80 basis points , the most since early August, creeping back to its highest levels since the euro zone debt crisis at more than 85 bps breached in the summer.

French bonds also pay a higher yield than Spain's for the first time since 2008, another sign that investors are no longer willing to look past the creaking public finances in France as fiscal and political questions hurt sentiment towards the euro zone's second-biggest economy.

How French bonds fare will depend on the country's budget, which will test how long the government can last. It needs to be finalised soon before being passed on to lawmakers by mid-October for approval.

Billions of euros in spending cuts and tax increases are needed to close a deficit that risks widening to more than 6% of output.

"I would not touch French government debt. There is too much uncertainty for the time being," said Francois Savary, chief investment officer at Genvil Wealth Management.

He was particularly cautious ahead of an Oct. 25 rating review by Moody's, which has said that worsening debt metrics could lead to a downgrade of the outlook on its rating -- higher than peers Fitch and S&P Global -- to negative.

2/ STOCKS SHUNNED

French stocks have rallied just over 2% since the new government was unveiled last week (.FCHI) , opens new tab, broadly in line with Europe's STOXX 600 (.STOXX) , opens new tab.

Yet the overall performance since French President Emmanuel Macron's June 9 decision to call a snap election remains lacklustre and analysts were not hopeful of a rebound anytime soon.

France's CAC 40 index (.FCHI) , opens new tab has shed roughly 4% since then, while Germany's DAX (.GDAXI) , opens new tab has risen around 3% and the STOXX 600 has shed just 0.3%. The underperformance is even more stark for French domestically-focused mid-cap stocks, which are down almost 8% (.CACMD) , opens new tab.

"The performance of French equities since the appointment of the new government has been unremarkable – probably as its durability remains questionable," said Frederique Carrier, head of investment strategy at RBC Wealth Management.

Genvil Wealth Management's Savary added that even though French stocks have cheapened since June, that didn't mean this was a market that needs chasing, with a political uncertainty premium still necessary.

3/ DON'T BANK ON IT

French bank shares, hit especially hard in June, also remain below levels traded before Macron's snap election announcement.

Societe Generale (SOGN.PA) , opens new tab, BNP Paribas (BNPP.PA) , opens new tab and Credit Agricole (CAGR.PA) , opens new tab - the three biggest French banks - are down by between 5% and 13% since then. Europe's bank index is up around 1.5% over the same period (.SX7P) , opens new tab.

Flora Bocahut, co-head of European banks research at Barclays, noted that while the underperformance of French banks had started to ease, signs of weakening business activity were an added concern.

France's services sector contracted sharply in September, a survey on Monday showed.

"Macro and political uncertainty creates downside risk for French banks and could last for months, but we expect French banks' earnings to rebound into 2026," said Bocahut, citing factors such as cost-savings measures.

4/ NOT HELPING

Euro traders are mostly preoccupied with the European Central Bank interest rate outlook rather than with French politics right now.

Since hitting two-month lows in June, the euro has rallied 4.8% to just over $1.11. This week, it hit its highest in over a year on investor expectations for steep U.S. rate cuts that have hurt the dollar.

A look at the euro's performance against other European currencies shows its struggles.

It has lost nearly 1% against the safe-haven Swiss franc in that time and is down by about as much against sterling . France's acute fiscal problems are adding more ballast. With a budget deficit running almost double the euro zone's 3% limit - this is "not a great environment for the euro," ING says.

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https://www.reuters.com/markets/europe/french-markets-remain-hostage-political-rollercoaster-2024-09-27/