Expectations are increasing that the European Central Bank will intervene monetaryly if the early French parliamentary elections spark widespread panic in the market, as monetary policymakers on the Old Continent prepare for their annual conference in Portugal next week, according to what the British Financial Times newspaper reported in a report.
According to the British newspaper, many investors have sold off French bonds in recent weeks, fearing that the far-right National Rally party, led by Marine Le Pen, or the left-wing New Popular Front coalition, will win a parliamentary majority in the upcoming elections.
A success for one of the far-right parties leading the polls could lead to further selling, with the spread between French and German government borrowing costs (the difference in yields on government bonds between the two countries, a key measure of political risk) already at its highest since the eurozone debt crisis a decade ago.
In the context, Bloomberg wondered what the result might mean for spending, and the European Commission scolded the country less than two weeks ago over the huge budget deficit, regardless of who wins.
Bloomberg Economics expects a clash with Brussels on this issue.
The Financial Times reported that German Finance Minister Christian Lindner this week urged the European Central Bank to stay out of what is happening, warning that if it intervenes to ease any financial turmoil after the French vote, it “will raise some economic and constitutional questions.”
But market watchers are scrutinizing the finer details of the European Central Bank’s latest bond-buying plan to see what it might do if the next French government goes on a spending spree that clashes with the European Union and financial markets amid rising French debt levels, the newspaper said.
Investors in particular fear that the massive sell-off in French debt could spark contagion in other European countries, as spreads on bonds in the continent widen.
The newspaper quoted Sabrina Khanich, chief economist at Pictet Asset Management, as saying that if the risk of fragmentation in France increases to alarming levels, the European Central Bank will intervene when necessary and maintain the safety of the euro.
Consequences of trauma
The head of the Italian central bank, Fabio Panetta, said this week that the European Central Bank must be “prepared to deal with the consequences” of shocks caused by “increased political uncertainty within countries.”
Panetta, a member of the European Central Bank’s governing council, added that the bank must be prepared to use “the full range of tools.”
According to the Financial Times, when the European Central Bank announced the “Transition Protection Instrument (TPI)” two years ago, giving itself the ability to help a country in crisis by purchasing unlimited amounts of its debt, most policymakers were hoping to keep markets under control without the need to… Use it at all.
The French elections threaten to provide the first test of the TPI, which was intended to “counter unjustified and uncontrolled market movements” that threaten monetary policy in the euro zone.
But economists disagree on whether the design of the ECB’s asset purchase plan, which has not yet been tested, would prevent it from buying French bonds.
The Central Bank has set 4 criteria for activating the “Transition Protection Instrument (TPI), the first of which stipulates that the country must be “compliant with the European Union’s financial framework.”
The European Commission announced earlier this month that it would open an “excessive deficit procedure” against Paris, over a budget deficit of 5.5% of GDP, well above the 3% limit under EU rules.
Enough space
“It would be illegal for the ECB to use the TPI in the case of France,” Eric Dor, an economics professor at IESEG in Paris, wrote on the social networking site K.S.
However, ECB officials are privately confident that they have enough room to maneuver to use the new scheme, even if a country like France is formally judged to be in breach of EU fiscal rules, the newspaper said.
If the policies of the next French government scare investors and cause a sharp repricing of French bond yields, the European Central Bank is unlikely to act, especially since officials hope that market discipline will encourage countries to respect the EU’s fiscal rules, the Financial Times reported.
But if this causes a full-blown market panic with investors randomly selling not only French assets, but also those of other heavily indebted eurozone countries such as Italy, the central bank will surely act.
The newspaper quoted the chief economist at the German insurance company Allianz, Ludovic Subran, as saying, “I am sure that they at the European Central Bank are already asking themselves this question… If France enters into a crisis, this means that Italy will likely also be in a crisis, and it will have to… European Central Bank action.
It is noteworthy that such shocks prompted the European Central Bank to intervene, as former European Central Bank President Mario Draghi made a memorable promise in 2012 to do “whatever it takes” to settle the markets, after the Greek debt crisis threatened to destroy the euro zone.
