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Hollande Forced into a Compromising Situation

Few politicians have had as bad a start to 2014 as Francois Hollande. Enough has been written about his private life already, but that aside - the situation with the French economy must be causing him even more sleepless nights.

Few politicians have had as bad a start to 2014 as Francois Hollande. Enough has been written about his private life already, but that aside - the situation with the French economy must be causing him even more sleepless nights.

Tuesday's press conference was supposed to be his opportunity to set the tone for 2014. It was to be a 'fresh start' for the Hollande Presidency, following a tough year which saw the approval ratings of both the President and Prime Minister Ayrault hit record lows.

His falling popularity is mainly the result of a stagnant economy and high unemployment, but the plan was to start the new year with a legitimate plan to resurrect the country, and hopefully to save his own Presidency. But in order to do so, he has to change policy and make a fairly obvious shift away from his core Leftist principles to some more resembling those of a Social Democrat.

Social spending and policy in France is the third rail of French politics. Get it wrong and you will suffer the consequences, however if you get it right then you will reap the benefits. France spends more on social welfare as a percentage of GDP (33% in 2012) than any other OECD nation, but during his press conference Hollande made the announcement that spending will have to be cut. A move to cut €30billion from payroll taxes on French businesses that had previously been directed to social welfare is the first step in a retargeting of French fiscal policy.

The tax cut is a 'carrot' to French businesses, with the 'stick' coming in the form of a 'responsibility pact' that the President wants companies to adopt in order to increase employment. Employment has continued to slip since Hollande took power 20 months ago - unemployment is around a per cent higher - and now sits comfortably above the 10% level. That remains below the Eurozone average, but how many proud Frenchmen are willing to settle for that? The likelihood is that the unemployment rate will run higher still in France as GDP is overtaken by the pace that people join the jobs market.

GDP in Q3 slipped back into negative territory for the fourth time in six quarters and PMI surveys have hinted at further recessionary pressures from both the services and manufacturing sectors. These PMIs have frequently underestimated French growth, much like the UK's versions have overestimated it, but what can be taken from this? Confidence within French industry is worse than it needs to be and could work against the recovery further on down the line.

The size of the problem is put into context when we think about the impact of these issues not just in France, but in the Eurozone.

Europe's second largest economy cannot be as weak as this. Unfortunately, with other members of the Eurozone performing closer to France's level than that of Germany, broad measures of European performance are now unreliable.

In the UK, we have to look at what is happening outside of London to get a sense of the "real economy". Taking Germany out of the European figures would make the numbers look worse but more realistic. The truth does hurt.

ECB actions around France are interesting. The European Central Bank, with a mandate of 'one size fits all' monetary policy cannot simply forget Germany when it decides on monetary policy and interest rates. The recent 0.25% cut will have hurt the Bundesbank and the discussions around negative rates will have it left the Germans absolutely furious.

The ECB recently decided to strengthen its forward guidance plan, further emphasising that the bank stands ready to loosen monetary policy if they believe it is necessary. Conditions for action would be tightening of money markets - further pressure on bank funding markets - or additional falls in inflation throughout the Eurozone, the trajectory of prices has been lower for a while.

All of this adds up to one thing. France holds the key to European growth in 2014. They cannot rely on Germany alone to drive the recovery. Where France goes so will the Eurozone and this is why Hollande has been forced to reconsider his fiscal policy, and move to the Right.

The President has certainly found himself in a tricky situation at home, following the revelations about his alleged affair with the actress Julie Gayet. However, with the French economy stalling he has also found himself faced with the reality of a having to make a big compromise on his own political beliefs.

Jeremy Cook is chief economist at currency exchange specialists, World First