France’s public debt is set to dominate the European Central Bank meeting, even though policymakers are widely expected to leave interest rates unchanged. The deposit rate is expected to stay at 2.5 percent after two increases this year. The energy shock linked to the conflict in the Middle East remains on officials’ minds, but the limited economic figures published since September do not appear likely to alter the bank’s course.
Andrew Kenningham, an economist at Capital Economics, said attention should quickly shift to France and to how the ECB responds to the current budget and political crisis.
Against polarisation in French society and difficulty launching reforms to repair public finances, the yield on French ten-year debt crossed 5 percent last week for the first time since 2002. The spread with the German ten-year bond passed 170 basis points, the widest since autumn 2011.
Investors are concerned by a French debt and deficit among the highest in Europe, a heated debate over the 2027 budget and uncertainty surrounding the presidential election. Political tension has increased in recent days amid strong social discontent and protests marked by violence and looting.
Contrary to general expectations, Moody’s took no rating action on French debt on Friday and left its assessment at Aa3 with a negative outlook. The agency said that rating, which describes debt of good quality, assumes that a 2027 budget reducing the public deficit will be adopted and that social tensions will ease somewhat in the coming months.
Higher French borrowing costs are a potential risk for the euro area if they spread to other countries, but an ECB intervention remains unlikely at this stage. Markets are asking when Frankfurt might activate the Transmission Protection Instrument, created in 2022 and never used, which in theory allows large purchases of government bonds to contain market stress.
Michel Martinez, chief economist at Société Générale CIB, said the bar remains high. He explained that the ECB would have to judge the widening of French spreads unjustified by fundamentals and a threat to monetary transmission across the euro area. He said such a judgment, highly political only months before the presidential election, could pull the institution into the national debate and raise doubts about its independence.
Christine Lagarde recently insisted that the means to stop the surge in yields on French debt must first be found in France.
The ECB decision will follow Wednesday’s decision by the US Federal Reserve, which is also expected to stay on hold after its September increase.
Inflation in the euro area reached 3.8 percent in September, a three-year high, while inflation excluding energy prices stayed almost unchanged. ING economist Carsten Brzeski said the rise in fuel prices has so far produced very few second-round effects. He added that the French crisis has even reduced the chances of another rate increase, because bond markets have partly taken over some of the ECB’s work.
The recent rise in global bond yields reflects concern about public indebtedness, inflation and the large financing needs of artificial intelligence. By making credit more expensive for households and companies, the move has effects similar to an increase in policy rates.
Most economists nevertheless still expect a final rate rise in December, when the ECB will have new growth and inflation forecasts.