France's borrowing costs rise as election uncertainty jolts debt investors

By John Geddie

LONDON (Reuters) - The uncertainty surrounding France's upcoming elections appeared to ratchet up for debt investors on Monday, as the premium over Germany that France pays to borrow in bond markets climbed to its highest in three years.

The chances that one of the two established political parties will regain power in May's vote was seen as diminishing after the Socialists on Sunday picked a hard-left candidate and as Conservative leader Francois Fillon battled to contain a scandal over fake pay.

Opinion polls showed centrist candidate Emmanuel Macron gaining ground on presidential favorite Fillon. But investors -- who have been increasingly skeptical of polls after political shocks in 2016 -- said the upheaval also increased the chances of a victory for euroskeptic, far-right leader Marine Le Pen.

The euro remains little ruffled by the vote. A dip in French stocks on Monday was in line with broader market moves (FCHI).

"A widening in French bond spreads is very much related to political events," DZ Bank strategist Daniel Lenz said. Both candidates from the establish mainstream parties are in trouble and the market interprets this as higher risk in that Le Pen could benefit from this."

French 10-year bond yields -- an indication of the rate the country would pay to borrow money for 10 years -- rose as much as 8 basis points on Monday to hit 16-month high of 1.12 percent .

The gap to benchmark German equivalents widened to over 60 basis points for the first time in three years.

Investors are concerned the wave of populism behind Britain's vote to leave the European Union and the election of Donald Trump in the United States could sweep French far-right leader Marine Le Pen into power in 2017.

Le Pen wants France out of the euro and while it is unclear if she could even hold, let alone win, a referendum, few think the bloc could survive without its second-biggest power.

A rise in bets against French debt, as suggested by futures markets, and signs that some of the country's most loyal debt investors are exiting, hint there may be more pain to come.

KBC's strategist Piet Lammens said the weekend's events could play into Le Pen's hands, as she may have more of a chance of defeating centrist Macron than the right-leaning Fillon in May's run-off.

Lammens said Macron would not only benefit from the scandal surrounding Fillon but would also get more support from moderate Socialists who would refuse to back their hard-left candidate Benoit Hamon.

But the latest polls suggest Macron actually has a better chance of defeating Le Pen than Fillon.

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Le Pen is expected to win the first round in late April but lose to both Macron and Fillon in the second round. Head-to-head against Le Pen, one poll on Sunday suggested, Macron would get 65 percent of the vote while Fillon would get 60 percent.