European stock markets retreated on Tuesday, pulled down by French equities as traders monitored the potential for the government to lose a confidence vote next month.

France's CAC 40 index plummeted more than 2% in early deals before paring losses to around 1.6% by the end of the trading session. The country's three main opposition parties said they would not back a surprise confidence vote called by Prime Minister Francois Bayrou on Monday for Sept. 8 over his budget plans.

Bayrou argues around 44 billion euros ($51 billion) in budget cuts are needed to reduce the French deficit, which totaled 5.8% of GDP in 2024, with his proposals including freezing welfare spending, pensions and tax brackets.

Erik Nelson, head of G10 FX strategy at Wells Fargo, called the outlook for French assets "not great" but said the outcome for Bayrou's government was not a foregone conclusion.

"I think part of the issue here is that European equities, the euro itself, have been a very popular momentum trade throughout the year. What we're seeing in the last couple of days has been a little bit of unwind."

"I don't know that Bayrou is definitely out. There's still some uncertainty there. He's got a lot of things he can offer the opposition," Nelson continued, including that the French minister could back away from a contentious proposal to cut two public holidays.

"They're walking a very fine line here, and given where market positioning is in European assets, there's a lot of risks."

Source: CNBC