By Yoruk Bahceli and Samuel Indyk
(Reuters) - French President Emmanuel Macron's shock decision to call a snap election, which polls suggest the far right could win, has rocked financial markets, exacerbating fiscal sustainability concerns in the euro zone's second-largest economy.
Markets have stabilised since the June 9 announcement but are far from recovering.
Polls put Marine Le Pen's National Rally (RN) first, mostly short of an absolute majority, with investors on edge ahead of two rounds of voting on June 30 and July 7. They weigh up the RN's fiscal reassurances against the risk of a spending splurge by a left-wing alliance, which polls second.
Here are five key questions for markets:
1/ Is there more pain ahead for French bonds?
The risk premium, or spread, demanded by holders of French debt over Germany's rose to 84 basis points on Friday, its highest since 2012, in the midst of the euro zone debt crisis.
With the RN rising in the polls, "I think people are taking their risk off the table," said ING senior rates strategist Benjamin Schroeder. One poll showed it could potentially cross the threshold for an absolute majority.
Investors reckon a return to the levels before Macron called the election is off the cards. The spread is up over 30 bps since.
Markets staying around current levels would cost France an additional by 800 million euros ($857.92 million) in the first year, 4-5 billion in the fifth and 9-10 billion by the 10th, its finance ministry estimates.
An absolute majority for the far-right or the left, which would allow them to implement more of their spending programmes, could push spreads even higher. Encouraged by RN comments on fiscal sustainability, many analysts see a left majority as a worse outcome for markets.
Whether Macron resigns may be key. Citi reckons the far-right or left implementing most of their programmes without Macron would raise France's spread to 130-135 bps, compared with 100-105 bps if he stays.
2/ Will turmoil spill into Italy and others?
French turmoil has also pushed spreads higher for the bloc's "periphery" of highly indebted member states.
Yet the moves have been contained. Italy's spread has risen to the highest since February, but at around 160 bps is hardly a level that causes concern.
Any further impact should be smaller than in 2017, when Le Pen's pledges to leave the euro and the European Union she has since abandoned shook the bloc's bonds.
"Given the lack of anti-euro rhetoric, contagion to the periphery ought to be limited," said Peter Goves, head of developed market debt sovereign research at MFS Investment Management.
Yet tensions between a new government and the EU could limit further European integration and "increase the vulnerability of the periphery to any shock," BofA says.
3/ How could banks fare?
French banks have been among the biggest losers from the turmoil. The big three - Societe Generale (OTC:SCGLY), BNP Paribas (OTC:BNPQY) and Credit Agricole (OTC:CRARY) - are down 10%-14% since Macron's announcement.
"French banks have a large amount of debt and they will suffer if you see higher credit costs or a sharp increase in borrowing at the government level," said Nathan Sweeney, chief investment officer of multi-asset at Marlborough.
"If it's Le Pen, does that mean windfall taxes or taxes on dividends? That creates uncertainty for banks," he added.
For now, the reaction has been excessive, said Barclays equity analyst Sam Moran-Smyth, given the limited earnings risk facing French banks at this stage, and valuations that were already depressed before the election announcement.
But Societe Generale and Credit Agricole are more at risk than BNP, given BNP's more diversified geographic and business mix, Moran-Smyth said.
4/ What about other French stocks?
The broader French market has not been spared - the blue-chip CAC 40 index is down 6% since Macron dissolved parliament.
Infrastructure and utility stocks suffered the most, with Vinci, Eiffage and Engie down over 10% since the election call.
The RN has previously pledged to nationalise highways, but left such plans out of its new programme. In the current campaign, it has laid out plans that disregard EU rules on power prices and to ramp up taxation on power producers' exceptional profits.
Corporate debt has also taken a beating. French companies are the biggest group in European corporate bond markets, making up 23% of ICE BofA's index, according to Janus Henderson.
5/ Is it lose-lose for the euro?
The euro is down 1% against the dollar since the election announcement and hit an eight-week low on Wednesday.
A hung parliament would be negative for the euro, but the worst outcome would be an RN majority, said MUFG senior currency economist Lee Hardman.
"In that scenario, we would see euro-dollar breaking to a new lower range, we think towards parity."
Further political uncertainty would benefit the Swiss franc the most, given its role as a regional safe haven, Hardman said.
($1 = 0.9325 euros)