Explainer: Why the ECB Is Unlikely to Step in for France’s Bond Market Issues
ECB Response to France’s Bond Market Turmoil
FRANKFURT, Oct 1 (Reuters) - The European Central Bank is again facing questions about whether it might help shore up France's bond market after yields soared to more than two-decade highs.
Persistently high deficits and debt, now among the highest in the euro zone as a percentage of GDP, mean investors are demanding an increasingly large premium to hold French government bonds. And with the far-right leading in polls ahead of a presidential election next year, President Emmanuel Macron appears unwilling or unable to push through the fiscal correction needed to shore up confidence.
The following looks at the ECB's options to help France and any other euro zone countries affected by contagion.
ECB Options for Supporting France
WHAT COULD THE ECB DO FOR FRANCE?
The Transmission Protection Instrument (TPI)
The ECB's Transmission Protection Instrument (TPI) allows it to buy an unlimited number of bonds from any euro zone country experiencing an "unwarranted, disorderly" tightening of its financing conditions.
The risk premium investors demand to hold French rather than German government bonds has risen sharply over the last month, reaching a 14-year high of roughly 131 basis points this week.
Likelihood of ECB Intervention
SO, IS THE ECB GOING TO STEP IN?
Key Criteria for ECB Action
Probably not.
Ultimately it is the Governing Council's decision. But France fails to meet several key criteria, which makes an ECB intervention legally contentious.
Market Drivers and Legal Constraints
Firstly, the market move is driven by concerns about the public finances and political turmoil including uncertainty around next year's election, making it difficult to say it is unwarranted.
Spreads over German debt, the de facto benchmark for the euro zone, have risen sharply but by relatively measured increments and reflecting the flow of news, meaning it is also hard to show it is disorderly.
France is already under a European Union excessive deficit procedure, failing a key ECB criterion. And with this year's budget deficit of 5.4% set to fall only to 5% next year, it is hard to argue it has the "sound and sustainable macroeconomic policies" demanded by the ECB.
Even French central bank chief Emmanuel Moulin has cautioned against betting on an ECB rescue.
ECB’s Flexibility and Policy Stance
The ECB did leave itself a loophole saying that these criteria are merely an "input" to decision making and will be "dynamically adjusted" in light of unfolding risks. But to date no ECB policymaker has suggested the bank should help France.
Market Movements and Precedents
IS THE RECENT MARKET MOVE EXTREME?
Comparison with Past Euro Zone Events
The French move is large but not unprecedented in the euro zone.
When TPI was created in 2022, Italy's central bank chief argued that spreads on its bonds of 200 basis points more than German debt were unwarranted and should be no more than 150 basis points. The ECB did not budge, however, and to date TPI has never been used.
Italian spreads then eased and were well under 100 basis points this year until contagion from the French turmoil pushed the spread to 110 basis points this week.
Contagion Risks Across the Euro Zone
WHAT ABOUT CONTAGION?
Potential ECB Actions for Other Countries
The ECB could have the legal power to help other countries should they suffer a disorderly and unwarranted rise in borrowing costs because of the turmoil in France.
"A more convincing case for TPI would be spread-widening that shows contagion across several euro zone countries," ING economist Carsten Brzeski said. "But even then, TPI would not have to be the first option. The ECB could first stop quantitative tightening and reinvest maturing bonds at its discretion."
Indeed, the ECB has in the past argued that bond buys are a powerful tool for stabilising financial markets during periods of stress.
Recent Spread Movements in Vulnerable Countries
Besides Italy, spreads have widened sharply in recent days for several countries considered more vulnerable. For Greece, it widened to 95 basis points on Thursday while for Belgium, it increased to 80 basis points. Portugal and Spain also saw modest increases.
(Reporting by Balazs Koranyi; Editing by Catherine Evans)