The European Central Bank has faced questions about whether it would shore up France’s rattled bond market ever since President Emmanuel Macron called a snap parliamentary election last month, raising the prospect of a far-right government.
Policy-makers remain in no rush to act, also in light of calmer markets since the first round of voting handed Marine Le Pen’s far right National Rally fewer seats than expected. But the risk of an RN-led government after Sunday’s second round is far from averted.
Here is what Reuters found out about the ECB’s thinking at its annual Forum on Central Banking in Sintra, Portugal, after conversations with more than a dozen Governing Council members:
What would it take for the ECB to start buying French bonds?
The ECB’s Transmission Protection Instrument (TPI) allows it to buy an unlimited number of bonds from a euro zone country that is suffering from a disorderly and unwarranted tightening in financing conditions.
The rise in the risk premium investors demand to hold French debt to a 12-year high of roughly 80 points a few weeks ago did not meet either condition, according to ECB chief economist Philip Lane, who described it as simple “repricing” in an interview with Reuters.
Another policy maker at the Sintra gathering said even a risk premium – gauged by the gap between French and benchmark German sovereign bond yields – of 100 basis points would not warrant action and another said the current spreads appear tight considering France’s high public debt.
In general, policy-makers would need to see a big enough rise in yields as to hamper the transmission of the ECB’s interest rates to the economy.
“If we conclude that transmission is working that’s the end of it,” Irish central bank governor Gabriel Makhlouf told Reuters.
An ECB spokesperson declined to comment for this story.
How about the ‘unwarranted’ part?
That is subject to interpretation and a little divisive. TPI comes with a number of conditions for eligibility, including compliance with the European Union’s fiscal rules.
This may prove a problem for France, which is under an “excessive deficit procedure” by the European Commission, although ECB President Christine Lagarde has said this is just “an alternative condition”.
Most governors think the ECB should take its cue from Brussels and not come to France’s rescue until Paris has hatched out a deal with the Commission about reducing its deficit.
But a couple of them admitted that the ECB’s hand might be forced well before that process, which is likely to take months, is completed.
This would particularly be the case if the bond selloff in France spreads to other debt-laden countries such as Greece, Italy, Portugal and Greece.
“The European Central Bank has to do what it has to do,” Lagarde said during a panel discussion in Sintra. “Our mandate is price stability. Price stability is obviously relying on financial stability, and we are attentive to that.”
What would the ECB do then?
European central bankers have not started making plans for this doomsday scenario and still hope TPI will never be used.
Some envisaged the notion of a temporary intervention, in the spirit of the Bank of England’s short-lived foray in the gilt market during the mini-budget crisis of 2022.
Financial market participants speculate the ECB might buy bonds from countries other than France but central bankers found the notion of fighting a fire without tackling its source unconvincing.
Others were petrified at the prospect of buying massive amounts of bonds from multiple jurisdictions, which may drag the ECB back to the world of money printing it is trying to leave behind.
Fundamentally, policy-makers want to avoid any commitment or hard rule so they can react as they see fit.
“I think it’s very important that we don’t give any signal to the market that we have some kind of automaticity, limits, or hard constraints in what we do,” Belgian governor Pierre Wunsch told Reuters. “The rule is that it must be unwarranted and disorderly. It will be a judgment call.”