The French election sparked panic, will the ECB intervene in the market?

The European Central Bank (ECB) is facing growing speculation that it could intervene if the results of France's new National Assembly elections spark widespread panic.

French President Emmanuel Macron announced the dissolution of the National Assembly and the holding of new National Assembly elections on the same night because the support of the French ruling party in the European Parliament elections that ended on June 9 was much lower than that of the far-right parties.

In the weeks that followed, French bonds were sold off on fears that the "right-wing coalition or the "New Popular Front" of the left-wing parties, led by the National Alliance, would win a parliamentary majority in the upcoming general election.

The spread between the French government's borrowing costs and the German government's borrowing costs, a key indicator of political risk, has reached its highest level since the European debt crisis more than a decade ago.

Against this backdrop, German Finance Minister Lindner recently urged the ECB to stay on the sidelines, warning that if the ECB intervenes to mitigate any financial turmoil after the vote in France, it will "raise some economic and constitutional issues".

Why did Lindner say that? The reason for this is that two years ago, the European Central Bank announced the launch of the "Transmission Protection Tool (TPI)" and gave it the power to help countries in crisis by buying unlimited amounts of debt. The French parliamentary elections are likely to be the first test of the TPI.

In a response to CBN, S&P Global Market Intelligence said that next week, in Europe, politics could overshadow the impact of economic fundamentals on the market: both the United Kingdom and France will hold general elections.

Whether the ECB wants to take action or not

France is scheduled to hold two rounds of voting for the National Assembly elections on 30 June and 7 July.

Pre-election polls show that the "right-wing coalition" led by the National Alliance continues to consolidate its leading position in major opinion polls, of which the "right-wing coalition" has a support rate of about 35%~36%, the "New Popular Front" composed of left-wing parties will receive 29% support, and the presidential camp led by Macron has a vote rate of 20%~22%. Overall, the presidential camp led by Macron ranks third in the polls, and the French stock and bond markets have been turbulent recently due to the lack of optimism about the election results.

For example, a week after Macron announced the election of a new National Assembly, the French stock market wiped off more than $250 billion in market value, and the CAC 40 index erased all gains in 2024 and fell from the throne of Europe's largest stock market.

French Finance Minister Le Maire has warned that France could face the risk of a financial crisis if far-right or left-wing parties win parliamentary elections.

Market watchers are examining the fine print of the ECB's latest bond-buying program to see what exactly the ECB will do if the next French government "splurges" and leads to a devastating conflict with the EU and financial markets over rising debt.

Investors are particularly concerned that a broader sell-off of French debt could trigger a contagion in other European countries, causing interest rates to diverge from each other.

Sabrina Khanniche, senior economist at Pictet Asset Management, said: "If the risk of fragmentation in France rises to a worrying level, the ECB will intervene if necessary to preserve the integrity of the euro." ”

In fact, Fabio Panetta, a member of the ECB's Governing Council and president of the Bank of Italy, recently said that the ECB should be "prepared for the consequences of shocks caused by increased political uncertainty within countries". He added that the ECB should be ready to use its "full range of tools".

One of the tools of the so-called ECB is the TPI. The ECB gives the tool the power to help countries in crisis by buying unlimited amounts of debt. At the time, however, most policymakers wanted to reassure the market without the need for TPI.

The French parliamentary elections are likely to be the first test of the TPI, which aims to deal with "unnecessary and disorderly market dynamics" that threaten monetary policy in the eurozone. However, economists still disagree on whether this is a tool or not.

Why do we struggle with whether to use TPI for the law?

The ECB has set four criteria for initiating the TPI, the first of which states that a country should be "in line with the EU's fiscal framework".

Earlier in June, the European Commission announced that it would launch an "excessive deficit procedure" for Paris, whose budget deficit is 5.5% of gross domestic product, well above the EU's 3% ceiling.

S&P also expects France's budget deficit to average 4.6% of GDP between 2024 and 2026, up from its previous forecast of 3.9%. By 2027, France's budget deficit will still reach 3.5% of GDP, higher than the French government's target of 2.9%.

Therefore, some economists believe that this means that France has already been excluded from the TPI. Edore, a professor of economics at the Paris School of Scientific Economics and Management, said that the ECB's use of TPI against France is illegal.

However, ECB officials privately also believe that even if a country like France is formally convicted of violating EU fiscal rules, they will have enough leeway to use the new plan. The ECB also said that the four criteria are only a "reference" for its Governing Council to make any decisions.

In fact, the key criterion for deciding whether to initiate a TPI may be whether the market reaction is judged to be "disorderly".

This was hinted at recently by ECB Chief Economist Philip Lane, who downplayed the sell-off in the French market after the French elections, arguing that it was a reassessment of fundamentals by investors and contrasting what he sees as "disorderly market dynamics".

At the same time, the ECB is unlikely to act if the policies of the next French government spook investors, but the sharp turmoil in French assets is followed by an orderly repricing.

But if this causes a full-blown market panic and investors indiscriminately dump French assets and those of other highly indebted eurozone countries such as Italy, then the ECB seems inclined to act.

Ludovic Subran, chief economist at Allianz, said: "I believe the ECB is already asking itself this question. If France is in crisis, then it means that Italy may also be in crisis, and the ECB will have to act. ”

It should be noted that such shocks in the past have prompted the ECB to intervene. Former ECB President Mario Draghi made a memorable promise in 2012 that he would do whatever it took to calm markets when the Greek debt crisis threatened the euro.

Christian Kopf, head of fixed income at German Investors United Investment Management, said: "If Italian interest rate differentials widen significantly, the ECB could activate the TPI to prevent the crisis from spreading to innocent bystanders." But my feeling is that we still have a long way to go from this kind of market intervention. ”

It is worth noting that ECB executives will hold their annual meeting in Portugal this Monday (1st), when the results of the first round of the French parliamentary elections have just been announced.

ECB President Christine Lagarde, a former French minister, seems certain to be asked how the ECB will respond to a possible financial crisis in Paris. Such a question can be treacherous. Lagarde made a gaffe in 2020 when she said "we're not here to narrow spreads" at the start of the pandemic, triggering a sell-off in the bond market. This time, Lagarde is likely to be much more cautious.

In addition, S&P Global Market Intelligence told CBN reporters that this week, there are still a lot of data releases in the primary market, including the latest Eurozone and German inflation data, as well as industrial production data from Germany and France. "Specifically, we will expect official confirmation of the easing of inflationary pressures in the Eurozone. The decline in the price index in recent months justified the ECB's interest rate cut in June. ”

(This article is from Yicai)