By Harry Robertson and Amanda Cooper

LONDON (Reuters) -French stocks and bonds fell sharply on Wednesday, driving the premium the government pays for long-term borrowing to its highest since the euro zone debt crisis of 2012, as investors grew uneasy over the fate of the new government and its budget.

Prime Minister Michel Barnier told French broadcaster TF1 on Tuesday that France could face fiscal turmoil if his government should fall.

Far-right leader Marine Le Pen has been threatening to topple France’s coalition government in a no-confidence vote over a disagreement with Barnier over the proposed budget, which contains measures to cut spending and raise taxes.

“There will be a big storm and very serious turbulence on the financial markets,” Barnier said when asked about the potential market fallout if the budget does not go through.

In Paris, the blue-chip CAC 40 fell 0.7%, making it one of the worst performing major indices in Europe, as shares in Societe Generale fell 3.5% and those in BNP Paribas and Credit Agricole slid 1.3-1.5%.

The premium of French 10-year government bond yields over German yields briefly rose as high as 90 basis points (bps), the most in over 12 years. It was last at 85 bps.

“French-German spreads are at their widest since 2012 and that is a challenge for the euro zone as a whole,” St James Place Chief Investment Officer Justin Onuekwusi said.

This gap, or spread, has been widening in recent weeks as investors demand a higher premium for the additional risk of holding French, rather than benchmark German, debt.

Six months ago, that spread was almost half what it is now, around 47 bps. It shot above 80 bps when President Emmanuel Macron called a snap election in June, raising investors’ concern about France’s political stability and its finances.

“With the spread now wider than the levels earlier this year – driven by fears over the potentially fiscally imprudent policies of both the far left and far right following the first round of elections – I would think we’re at the upper end of the range,” Gareth Hill, a fund manager at Royal London Asset Management, said.

He said he expected Le Pen and Barnier to eventually extract concessions from one another and reach some kind of agreement and, as such, this week’s drop in French bond prices might present a buying opportunity.

“In terms of positioning, we think these moves are overdone, in the short term at least, and have been buying France out of Germany across a number of our funds, moving from neutral France to a small overweight,” he said.

With French public finances increasingly out of control, the 2025 budget bill seeks to squeeze 60 billion euros ($63.10 billion) in savings via tax hikes and spending cuts. The aim is to cut the deficit to 5% of economic output next year from over 6% this year.

The Senate begins examining the budget bill on Monday.

Ratings agency S&P is scheduled to issue an update to its assessment of France’s creditworthiness on Friday.

At its last review in late May, S&P downgraded France’s long-term sovereign bond rating to “AA-” from “AA” and cited expectations that higher-than-expected deficits would push up debt in the euro zone’s second-largest economy.

French 10-year bond yields were unchanged at 3.021% on Wednesday, lagging a rally in the broader fixed income market, where yields fell as investors scooped up debt.

The yield on French 10-year bonds is almost on a par with that of Greek 10-year debt – the biggest casualty of the 2012 crisis – currently at 3.056%.

The cost of insuring five-year French sovereign debt against default also rose to its highest since late June on Wednesday.

($1 = 0.9509 euros)

(Additional reporting by Leigh Thomas in Paris and Dhara Ranasinghe and Yoruk Bahceli in London; Graphics by Harry Robertson and Samuel Indyk; Editing by Alexandra Hudson, Bernadette Baum and Jan Harvey)

---