How will the ECB respond to France being such a fiscal problem?

via notayesmanseconomics

Today we have an opportunity to look at a theme that way predates even my time on here. It is the claim by the Euro area founders that it would provide economic convergence for its members. Back in the day when I worked at Deutsche Bank in the mid-1990s  their offshore investment vehicle place an enormous trade buying French bonds and selling German ones. This was in the period of the expected run-up to the Euro called the ERM or Exchange Rate Management. Back then it went extremely well.

Now we see a very different world and let me hand you over to Reuters.

LONDON/PARIS, September 21 – The premium France pays to borrow on the bond markets compared to Germany rose to more than a whole percentage point on Friday for the first time since the euro zone debt crisis, underscoring investor unease with its stretched finances ahead of elections next year.

So we have passed what is a synbolic level and it exceeds the 86 and 87 we saw in the more recent political crises there. There is another sub-plot here because there has been the issue of at what point the ECB which is presently led by a former French Finance Minister Christine Lagarde would interene? It has a vehicle to do so in Outright Monetary Transactions or OMTs which were created by her predecessor but as they have never been used in practice there remains a lot of uncertainty around them.

Finance Minister Lescure

Regular readers may recall that Roland Lescure came to attention earlier this year. On the 29th of May when I was continuing on my theme of the French economy being in trouble I pointed out this.

France Fin. Min. Lescure: There is no need to be alarmed about French GDP (@FinancialJuice)

That has not aged well and will not have helped the response to his interview with Bloomberg on Thursday.

Speaking to Bloomberg Television, Lescure said France shouldn’t abandon its plan to get the shortfall back to 3% of economic output in 2029.

“We shouldn’t throw out the anchor of 3%,” he said Friday on the sidelines of a meeting of European finance officials in Dublin. “It is a target we should all have in mind” as France strives to stabilize its debt levels.

This was a case of especially bad timing as of course many other countries in Europe have long considered that France has long ignored the Stability and Growth Pact rules that have been applied to others. They will note he refers to the annual 3% of GDP rule but not the 60% national debt one because France is approaching double that.

The particular problem was this.

Lescure’s comments come after the government announced late Thursday that weaker growth and higher interest costs mean the budget gap will swell to 5.4% of economic output this year, while the finance law had targeted a slight reduction to 5%.

As you can see convincing people you are going to hit a target hits troubled water when you have just missed a much easier one. That is before we get to the issue raised by Britney.

Oops, I did it again
I played with your heart
Got lost in the game
Ooh, baby, baby

Or if you prefer France has been a serial offender on this front. Plus does anybody actually believe this is possible in the current position?

Prime Minister Sebastien Lecornu said he’ll propose a €54 billion ($62 billion) effort to curb spending to meet the 5% goal next year. But he faces a struggle adopting those measures with no majority in parliament and opposition groups unwilling for compromise just seven months from presidential elections.

If we return to Finance Minister Lescure we are told this.

Next year’s deficit goal is “both ambitious and realistic,” he said. “It’s important for us to tell the markets: we are aware of those deficits.”

The Economic Growth Problem

On July 30th I pointed out this.

So we have an escape in literal terms but remain with a reality of very slow growth as that adds up to a mere 0.1% for the first half of the year. So has France replaced Germany as the sick man of Europe?

France had dodged a literal recession and if you look at the detail of its official releases dodged is a better word than escaped. Because on the 28th of August France’s official statisticians decided that they in fact agreed with my analysis.

Gross domestic product (GDP) in volume terms remained stable in the second quarter of 2026, following a 0.2% decline in the previous quarter.

Suddenly France was in the economic recession I had predicted. Shame on you if you are thinking this was conveniently after the media circus had moved on! Also I find the excuse that farmers did not now what they had produced to be weak at best and politically convenient.

These revisions reflect the even worse situation in agricultural production compared to the information available at the end of July, as well as the fact that prices in market services, which were not fully known at the end of July, turned out to be more dynamic than anticipated, particularly in transport services.

But the real issue to my mind is the fact that over the previous year GDP growth was a mere 0.3% and as 0.7% was at the end of last year unless something changes it could easily get worse. We can link with the next section here because ECB President Christine Lagarde and one of her possible replacements Dr. Isobel Schnabel are particular fans of the PMI business surveys of which the latest is below.

Falling from 49.6 in July to 48.0 in August, the headline
measure signalled a further and quicker contraction in
activity levels across France’s services economy. Weaker
demand was often mentioned as a drag on output by survey
respondents.

The outlook was disappointing too and let me zero in on an area that is significant for the public finances via tax revenue.

“The labour market also continues to demonstrate a frailty,
with service sector payroll numbers falling for a fourth
month running.”

The ECB

This is a space complicated by the balance sheet shuffling we have seen from our central banks and Treasuries most recently by my home country the UK. My Friday update explained why the Bank of England move was in fact very significant and there is more detail in the podcast below. But we find ourselves in an arena where whilst one might previously have expected the ECB to be active it is presently shrinking its balance sheet for now anyway. Also there are the words of ECB President Lagarde from the press conference on the 12th of March 2020.

we are not here to close spreads^[1]. This is not the function or the mission of the ECB.

Perhaps that is why there are rumours again of her leaving early as she has a track record of running away from problems she has created like giving the largest IMF loans ever to Argentina.

Also there is the issue of size because with a national debt of 3.5 trillion Euros that is a lot for even the ECB to swallow.

Comment

It is interesting that even with the bad news for the German government over the weekend that France is still relatively struggling. Another perspective comes from my home country the UK which is also a big spender but not quite as much and has some economic growth. However French bond yields are lower by around three quarters of a percentage point.

Also this news over the weekend did not help.

In addition to soaring prices, fuel supplies are becoming strained in France. On Sunday morning, 15% of service stations in mainland France were lacking at least one type of fuel, according to the Ministry of the Economy. (lessential.com)

Now I am sure there are also problems elsewhere but for now the focus is on France.