France Turmoil Threatens to Drag ECB Into Bond Market Showdown

From street protests to a bond market rout, France’s multiple crises are threatening to drag the European Central Bank into the kind of faceoff with investors that it hasn’t seen since the euro area’s debt crisis more than a decade ago.

As the prospect of government collapse and another deficit blowout loom, candidates to succeed President Emmanuel Macron in May are increasingly loading pressure on the ECB to step in to buy bonds or even cancel debt.

The tensions have escalated to threats in recent days, with far-left firebrand Jean-Luc Mélenchon saying he’d pursue Bank of France Governor Emmanuel Moulin for treason if he wins the election.

“Until now, I only knew of one country where people tried to intimidate a central banker, and that’s Trump’s America with Jerome Powell,” Moulin said Wednesday on France Inter radio. “I refuse to be intimidated. I will continue to say what I think within the framework of my mandate, and to defend the institution that I preside.”

Investors are responding to the political and economic crises by dumping French bonds. The 10-year yield premium on 10-year government debt over German peers has more than doubled since the end of May. Last week it hit the highest since the euro area debt crisis in 2011. While it’s pulled back from that peak, the spread was about 12 basis points higher again on Wednesday at 139 basis points.

Read more: France’s Decades of Deficits Bring Home a Painful Risk Premium

The sense of unease is compounded by student protests over funding for education and the system for university applications. The demonstrations sparked sporadic violence in the last week, leading to thousands of arrests.

But there’s little room for officials to spend their way out of the crisis this time. The ballooning budget deficit is the root cause of investor unease.

Far-right leader Marine Le Pen, who is ahead in presidential polls, outlined a program for a drastic reduction in the deficit on Tuesday, but also demanded the ECB take action to reduce borrowing costs. That would free up tens of billions of euros for European countries to invest in areas including defense, sovereignty and adapting to climate change, she said.

“It is vital to start a discussion with the ECB so that it intervenes to lighten the burden of rates as France takes back control,” Le Pen said at a presentation in Paris.

Moulin dismissed that demand, saying that while France’s situation is serious, it’s up to the government to take action and reduce a budget deficit.

“The ECB is not there to deal with the fiscal problems of countries — it is there to fight inflation and have inflation around 2%,” he said. “So the conditions are not met today for an intervention from the ECB.”

The ECB has tools to step in and buy bonds on markets, as it did during the Covid pandemic. But with a mandate to ensure price stability and inflation outstripping the central bank’s 2% target, it is instead moving in the opposition direction by tightening policy with interest rate hikes.

The central bank also has a tool known as the Transmission Protection Instrument, which was created in 2022 when market jitters involved Italy. But it’s not clear France would meet the criteria to unleash the massive bond buying it in theory allows.

Finance Minister Roland Lescure, who will meet with investors in London on Thursday, said on Tuesday that France is far from needing the ECB to step in and circumstances are different from the euro area debt crisis when banks were in danger and countries struggled to issue debt.

Still, investors are increasingly assessing where the central bank’s limits might be tested, and watching for signs of policy makers showing any inclination to act.

“Markets have, however, learned that Europe and its financial institutions are nothing if not creative in the event of a crisis,” said Jeremy Batstone-Carr, European strategist at Raymond James. “Just because limitations exist in prevailing terms and conditions does not mean that they cannot be tweaked.”

Le Pen Vows to Cut French Deficit, Calls on ECB to InterveneFrench Student Unrest Spreads as Teachers Join ProtestsECB Has No ‘Miracle Solution’ for France’s Debt, Moulin Says