• HSBC (HSBC) downgrades France to Underweight, citing fiscal deterioration and weak earnings; upgrades Italy to Overweight.
  • Equity fund flows are shifting from France to the UK, though HSBC remains Neutral on UK equities overall.
  • The bank stays Overweight European technology and financials, expecting higher bond yields to support bank profits.

HSBC has cut France to Underweight and raised Italy to Overweight in its latest European equity allocation, as concerns over France’s fiscal trajectory and political gridlock prompt investors to rotate capital toward the UK, according to the bank’s research. The shift underscores a growing divide within Europe, where France’s deteriorating public finances and weakening earnings momentum contrast with a more stable outlook elsewhere.

"European equity funds are shifting capital from France toward the UK," HSBC said in a note, citing worsening public finances, weaker growth forecasts, and deteriorating analyst earnings expectations. The bank also flagged pressure on French consumer-discretionary companies, which are particularly sensitive to domestic demand.

The move is France-specific rather than a broad retreat from Europe. HSBC remains constructive on European equities overall, especially technology, and sees financials as supported by higher bond yields. The bank recently increased its STOXX Europe 600 year-end target to 680, reflecting expectations of earnings growth of about 15.6% in 2026 and 15.4% in 2027.

French Fiscal Risk in Focus

At the heart of the downgrade is France’s fiscal outlook. The 10-year French government-bond yield spread over Germany exceeded 100 basis points—104 bp at the time of a recent Reuters report—for the first time since 2012. That represents the extra return investors demand to hold French debt rather than German bunds, a key gauge of sovereign risk.

The OECD forecasts French growth of just 0.4% in 2026, compared with 1% for the euro area. The deficit is expected to be 5.4% of GDP in 2026, while the Finance Ministry expects debt at 119.3% of GDP this year and 121.7% in 2027. Higher global energy prices and a broader sovereign-bond selloff have compounded the challenge, as France refinances large volumes of debt issued during the low-rate COVID era. The government expects debt-service costs to be €4.5 billion higher than expected this year and another €10 billion higher next year.

"Weaker growth makes fiscal repair harder; larger deficits raise bond yields; higher yields enlarge interest costs," HSBC noted, describing an adverse feedback loop that could further pressure fiscal credibility and domestic demand.

Politics adds another layer of uncertainty. Prime Minister Sébastien Lecornu is trying to advance a €54 billion savings plan, primarily through spending restraint, to prevent the 2027 deficit from exceeding 6.5% of GDP without action. The stated target is 5% of GDP. But the plan faces a fragmented parliament, and two preceding governments were brought down over budget fights. The government has said it will seek a parliamentary vote rather than use Article 49.3 executive powers. The 2027 presidential election further clouds the outlook, with both far-right and far-left fiscal-policy risks on investors’ radar.

UK Benefits, But Not Without Caveats

The rotation toward UK equities does not imply the UK is fiscally risk-free. UK long-dated gilt yields have also been rising sharply amid global duration selling and concerns about public-finance pressures. Instead, the relative appeal reflects France’s more acute combination of fiscal deterioration, political gridlock, and weakening earnings revisions.

HSBC sees potentially better earnings momentum in UK mid-caps, projecting 2027 earnings-per-share growth of 14% for the FTSE 250 versus 5% for the FTSE 100. That distinction matters: HSBC had previously reduced its broad UK-equity stance to Neutral in July, so fund managers can prefer UK exposure relative to France while still having limited enthusiasm for the UK market overall.

Meanwhile, Italy’s upgrade to Overweight reflects improving regulatory stability and growing appeal for private-market investors. At Bloomberg’s Future of Finance conference in Milan on Thursday, Blackstone (BX)’s country Chairman Andrea Valeri said Italy’s “regulatory stability” has improved the perception of foreign direct investors. “Italy in this regard has been on a very steady growth trajectory,” he added. Cecile Mayer-Levi, head of private debt at Tikehau Capital (TKKHF), noted that partnerships with banks are well established, calling it “much more of a convergence between the two solutions.” KKR & Co. recently closed a €22 billion deal for a majority stake in Telecom Italia (TIT.MI)’s Netco, underscoring growing private equity interest.

Sector Positioning and Market Implications

HSBC remains Overweight European technology, where consensus estimates imply 27% earnings growth in 2027. However, the bank cautions that technology earnings expectations have softened and the sector remains relatively under-owned. It also expects financial stocks to stay supported by higher bond yields, which can boost bank profitability through lending margins and reinvestment income. That view aligns with HSBC’s own first-half 2026 results: banking net interest income rose $1.6 billion to $22.9 billion, with a net interest margin of 1.61%.

Still, excessively high yields can eventually hurt banks by raising defaults, impairing bond portfolios, and weakening credit demand. HSBC’s first-half expected credit losses rose to $2.4 billion, including exposures related to UK fraud/securitisation and Hong Kong commercial real estate.

On the equity side, the CAC 40 was down about 0.5% year to date as of September 25, while the STOXX Europe 600 had gained roughly 8%, illustrating France’s relative underperformance. HSBC sees European companies becoming more domestically oriented, with domestic revenue exposure rising to 51.2%, its highest since 2017. That favors businesses linked to local investment, infrastructure, defence, and household demand—but the bank cautions that investor positioning in domestic sectors may already be rich versus their earnings outlook.

The immediate test for France is the 2027 budget, expected to be unveiled on October 1. Passage is uncertain given the lack of a clear parliamentary majority. Failure to pass a budget, a government collapse, or a materially weaker fiscal plan could widen the France–Germany yield spread further; Société Générale has not ruled out 120 bp, according to Reuters. If France can secure a workable budget and curb the deficit trajectory, some investors may judge current yields sufficiently compensatory—one strategist cited by Reuters had already closed a short-French-bond position on that reasoning.

For now, HSBC’s stance is clear: a country-allocation warning inside an otherwise constructive regional thesis. The bank’s fund-flow observations point to a continuing rotation toward the UK, even as it maintains a Neutral view on UK equities overall. As Valeri of Blackstone put it, “What institutional investors like us are really focused on is regulatory stability.” For France, that stability is now in question.

Correction: October 1, 2026 — An earlier version of this article misstated the year of the 2027 budget unveiling. It is scheduled for October 1, 2026, not 2025. Additionally, HSBC’s STOXX Europe 600 year-end target was increased to 680, not 580.