The spread of social unrest in France is undermining investor confidence in the euro and raising fears of an interest rate hike in the euro zone, a prospect that is taking a heavy toll on bonds.
The euro plunged to a two-year low versus the dollar as youths across France torched more than 1,000 vehicles despite government plans to impose curfews to quell 2 weeks of violence.
Investors remained on edge as a few cars were also burnt in Brussels in what appeared to be an imitation of the violence in France, though there is so far only limited evidence that the unrest is spreading beyond the euro zone's second largest economy.
"I think there are some concerns about the way Europe is evolving both economically and socially," said Jon Lee, interest rate strategist at Barclays Capital in London.
"In terms of the French rioting and that spreading anywhere else, it continues to underpin just how volatile society may prove to be should unemployment remain very high and there generally (continue to) be these grievances," Lee said.
Some economists agreed with Lee's assessment and said the violent protests could, if they last, deepen the gloom felt by French consumers who are already fretting about weak economic growth and chronic unemployment around 10 percent.
Paris-based Nicolas Bouzou, chief economist at the Xerfi economic think-tank, said the violence would probably have most impact on confidence within the French economy.
But Exane-BNP economist Emmanuel Ferry played down any direct economic impact of the troubles for the time being.
"As long as the smart areas of Paris remain untouched there won't be much impact on consumption," he said.
Strategists said the violence highlighted social problems buffeting France but that despite the graphic images that have captured global attention, the scale of disruption remained limited for now and was unlikely to dent investor confidence.
"It is dramatic news and there are some serious social problems in France. But stock markets are driven by the interest rate outlook, GDP growth and corporations' ability to restructure and innovate. All these things don't change," said Teun Draaisma, Morgan Stanley co-head of European equity strategy.
"Socially it's a big thing but I don't think this will affect the stock market at the moment. If it escalates further it might but it would have to be a massive escalation for it to really hurt the market," Draaisma says.
France is in the middle of a politically sensitive share sale worth up to 7 billion euros at its state power giant EDF and analysts said the riots could scare some investors away.
But they were pointed out that the deal, the world's largest initial public offering in four years, was seen by some in the market as too expensive. French power workers staged a one-day strike on Tuesday to protest against the plans.
Analysts say the spreading violence along with the uncertainty over the shape of the Germany's "grand coalition" has the potential of raising risk premium on European assets.
A plan to increase German indirect taxes, which risked boosting euro zone inflation, was another factor which could spur ECB to raise rates and keep consumers out of the shops.
The euro last traded down about 0.60 percent versus the dollar, after having hit a two-year low. Euro zone government bond yields meanwhile hit multi-month highs as ECB officials kept up hawkish rhetoric against inflation.
"The German coalition is foundering, 47 French politicians have been done for fraud, the Italian finance minister has resigned accusing the central bank of malpractice and young Parisians are into their second week of rioting and I am supposed to like this currency on the basis that the ECB might kill off any nascent recovery?" said Mark Tinker, head of strategy at Execution Limited.
The rioting ironically has swept the French public contracts scam, in which most of the 47 accused including a former aide to President Jacque Chirac were convicted, off the front pages.
Others were less pessimistic and said French riots were just a factor in the overall picture adding to weakness in the euro.
"I think everyone is trying to bring euro risks forward. It fits in the overall equation but I think there is no fear of it being escalated and having a larger impact on the economy," said Paris based Neils Christense, senior currency strategist at SG.
"I think it will die down.".
