How bad does it have to get for the ECB to save France?

French borrowing costs are surging and central bankers are starting to fret. Some of them, at least. The head of the French central bank, Emmanuel Moulin, told the Financial Times that his country risks being “strangled by interest rates”. The best solution, he made clear, was for the French government to cut costs and reduce the deficit, which, in an unchanged scenario, could reach upwards of six percent next year. Last week, the French minority government proposed €43bn worth of cuts for 2027. But pushing them through parliament is a tall order in a divided country. Meanwhile, investors are dumping French bonds, pushing up French government borrowing costs compared to German benchmark Bunds. This is already immensely costly to French society. “In three weeks, we’ve lost the equivalent of €15bn a year in higher debt-servicing costs over a 10-year horizon, or almost €100bn cumulatively over 10 years!”, French economist Shahin Vallée said on social media last week. The gap, or spread, between French and German bond yields, historically around 50 basis points (0.5 percentage points), was 109 basis points when he wrote it on Wednesday. It is now 30 points higher. Spreads are a crucial marker for financial stability because they show how nervous investors are. The bigger the spread, the higher the perceived risk. And France’s parabolic bond spread is already bringing back unwelcome memories of the eurozone crisis in November 2011, when the spread reached 200 basis points. Bypass parliament? The question is what to do about it, and who is best positioned to act. The French government could bypass a parliamentary vote or push through the budget by ordinance, under articles 49.3 and 47 of the constitution, respectively. There are downsides to both. Bypassing parliament could trigger a no-confidence vote. An ordinance, meanwhile, can only be used after a 70-day grace period, which means another two months or so of uncertainty. It is unclear in any case whether a budget agreement will significantly alter the situation. "France is a genuinely deflationary problem," former hedge fund manager and economist Eric Lonergan explained in a recent blog. If France's borrowing costs stay high, the government is forced into austerity, which cuts spending and demand. French banks hold lots of French bonds, and falling bond prices (yields and prices are inversely related) hurt their balance sheets, which means money flees into more stable German Bunds, which then tightens financial conditions further. "It's not 2008 or 2011," European Central Bank (ECB) president Christine Lagarde told French newspaper La Croix last week when asked whether France was the new "sick man of Europe." "I have seen Greece, Ireland … put their public finances back in order and restore confidence," she said. "Those countries have since returned to growth, often at levels above the average." Source: IMF What she didn't say is what it cost. After 2009, Greece was driven into "one of the most devastating economic crises on record", economic historian Adam Tooze wrote in 2022, a slump "as bad, but far more sustained than America’s Great Depression of the 1930s." Will the ECB step in? France is not Greece. A full-blown debt crisis is not yet on the cards. But as things stand, a protracted muddling through seems a likely outcome, possibly one of the more positive ones at that. The ECB could step in if it wanted to. It could stop letting its bond holdings shrink, as Bruegel's Mahmood Pradhan argued in June. Or it could buy French bonds outright under its Transmission Protection Instrument, which was created to stop a country's yields from spiralling. But the TPI comes with conditions, including compliance with EU fiscal rules. And some member states would baulk at bailing out France, meaning the ECB will likely only consider using this tool if the threat to EU economic stability is "existential", with spreads closer to 250 basis points, said Charlotte de Montpellier of ING, a bank. As de Montpellier and her colleagues noted last week, France's fiscal plans, even if approved by parliament, won't stabilise French debt, and the spread is likely to hover around 150 basis points. French finance minister Roland Lescure, for his part, told reporters on Tuesday that the country doesn't need the ECB to step in. But whether France needs the ECB to step in or not, the better question is how bad it has to get before it does.