Francesco Canepa and Ballas Colani
SINTRA, Portugal (Reuters) – The European Central Bank is facing doubts about whether to support France’s shaky bond market after President Emmanuel Macron called early parliamentary elections last month, raising the prospect of forming a far-right government.
Policymakers are in no rush to act, with markets calmed after Marine Le Pen’s far-right Rally National party won fewer seats than expected in the first round of voting, but the risk of a Rally National-led government being formed after Sunday’s second round is by no means averted.
Reuters spoke to more than a dozen Governing Council members at the ECB’s annual central bank forum in Sintra, Portugal, and learned the following about the ECB’s thinking:
What would it take for the ECB to start buying French government bonds?
The ECB’s Transmission Protection Instrument (TPI) allows it to buy an unlimited amount of bonds from euro zone countries suffering from a disorderly and unjustified tightening of financing conditions.
The rise in the risk premium investors demand to cap French government bonds at around 80 percentage points, a nearly 12-year high, raised a few weeks ago does not meet either condition, ECB chief economist Philip Lane described it as simply a “repricing” in an interview with Reuters.
Another policymaker at the Sintra meeting said a risk premium of 100 basis points, measured as the difference between French and German government bond yields, would not require action, while another said the current spread looked narrow given France’s high public debt.
Generally, policymakers would need to see yields rise enough to prevent the ECB’s interest rate from being transmitted to the economy.
“If we conclude that economic transmission is working, then that’s it,” Central Bank of Ireland Governor Gabriel Makhlouf told Reuters.
An ECB spokesman declined to comment on the matter.
What about the “unfair” part?
It is open to interpretation and somewhat controversial. The TPI comes with several eligibility conditions, including compliance with European Union fiscal rules.
This could be a problem for France, which is undergoing an “excessive deficit procedure” by the European Commission, but European Central Bank President Christine Lagarde has said it is just a “fallback condition”.
Most presidents believe the ECB should follow Brussels’ lead and not bail out France until it reaches an agreement with the European Commission to reduce its budget deficit.
But several members acknowledged that the ECB may be forced to act long before the process, which is expected to take several months, is completed.
This would be especially true if the bond selling in France spreads to other indebted countries such as Greece, Italy and Portugal.
“The ECB has to do what it has to do,” Lagarde said at a panel discussion in Sintra. “Our mandate is price stability. Price stability obviously depends on financial stability and we are paying attention to that.”
What will the ECB do then?
European central banks have not begun to plan for this doomsday scenario and still hope that TPI will never be used.
Some have fancied the idea of temporary intervention, similar to the Bank of England’s brief foray into the gilt market during the 2022 mini-budget crisis.
Financial market participants have speculated that the ECB may buy bonds from countries other than France, but central bankers find the idea of trying to put out a fire without fixing its cause untenable.
Some are frightened by the prospect of buying so many bonds from multiple jurisdictions, which could pull the ECB back into the world of money printing that it is trying to escape.
Essentially, policymakers want to avoid any promises or hard and fast rules so they can respond as they see fit.
“It is very important not to give the market a signal that there is any automaticity, any limitation or any hard constraint on our actions,” Belgian Governor Pierre Wunsch told Reuters. “The principle is that it must be unjust and disorderly. It will be down to judgment.”
(Reporting by Francesco Canepa and Emilia Sitore Matarise)
