ECB approach to French storm can be a Gallic shrug

Whatever it doesn’t take. History repeats itself, first as tragedy then as farce. Karl Marx’s maxim is getting more and more apt for France, whose debt is hitting levels of perceived riskiness not seen since the catastrophic euro zone debt crisis in 2012. Yet although politicians are threatening to throw out Prime Minister Michel Barnier, European Central Bank President Christine Lagarde can afford to monitor developments rather than shape them.

Even if President Emmanuel Macron can cobble together a new government as and when Barnier gets the boot, France looks rudderless. A new administration would struggle to push through tough measures to bring the deficit down from 6% of GDP expected this year. The extra premium investors demand to hold 10-year French bonds over equivalent German debt reached 88 basis points on Monday, higher than Greece’s, and up over 30 basis points since June.

Yet if France is stuck in a 2012 loop, the rest of the euro zone isn’t. Even as French spreads have risen, those in Italy have stayed relatively stable. Back in September 2012, Italy’s equivalent premium was over 400 basis points, not the current 120 basis points. Hence Lagarde has little reason to deploy the ECB’s scope to buy up French or other member states’ debt.

France still warrants careful monitoring, though. Investors have little reason to believe it can tame a debt burden that has risen from over 80% of GDP in 2009 to around 110% this year. Capital Economics reckons France would need to cut its primary deficit by 3% of GDP to keep its debt stable over the next 10 years, and expects borrowing to reach 123% of GDP in 2034.

A further rise in spreads could hurt France’s economy. Rating agencies might downgrade French bonds, which are currently five notches above those of Italy, according to S&P, at AA-minus. And borrowing costs for banks and companies will rise. Société Générale, for example, has already seen the cost of insuring its subordinated debt spike by nearly 40 basis points since June.

French spreads may keep rising: Capital Economics reckons they could reach 150 basis points. The risk then is that the euro zone economy stutters. And fears of monetary union breakup might creep in if a new French government refused to abide by European rules.

Yet the ECB still has options even then. It could cut rates, bringing down funding costs across the bloc. And Lagarde could announce bond purchases for countries that are sticking to EU rules, through the Transmission Protection Instrument tool she herself developed. That would reduce the risk of a 2012-style implosion – but still keep the heat on France’s leaders to get their act together.

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French Prime Minister Michel Barnier may be ousted in a no-confidence vote on Dec. 4.

French government bonds now yield around 84 basis points more than equivalent German debt. That’s up from below 50 basis points in June.