ECB Insight: While Ultimately Unlikely to Give Fragmentation a Pass, Insiders Hate to Even Think About TPI and France

5 July 2024

By David Barwick – FRANKFURT (Econostream) – European Central Bank insiders show great reluctance even to consider a priori the use of the transmission protection instrument (TPI) for the benefit of France, but seem disinclined to tolerate fragmentation, were it to really come to it, based on the views of various Eurosystem insiders who spoke to Econostream recently on the subject.

Introduced by the ECB in July 2022 to safeguard against financial fragmentation, the hope was always that it would be sufficient – without actual use – if the ECB had at its disposal a formal tool for countering increases in the interest rates on euro area member countries’ sovereign debt when such increases were deemed out of line with macroeconomic fundamentals.

This having worked perfectly so far, insiders understandably react decidedly negatively to the idea of the actual use of the TPI in connection with market concerns that the fiscal affairs of the euro area’s second-largest economy, already eyed warily, would further erode in the wake of a rise to power by the right.

Insider one referred back explicitly to the founding principle of deterrence. ‘If the conditions for its use were met, then it would be used, and market participants who assumed otherwise, or at least bet accordingly, would regret it’, he said. ‘But the point is that they realise this, so it will not have to be used.’

However, notwithstanding the conditions formally required for TPI deployment, that person acknowledged that the ECB had a certain amount of policy discretion, suggesting that the ECB would in no case let serious fragmentation go unchallenged.

The thinking of two out of three other insiders largely echoed the latter idea, while all three others rejected TPI deployment based on a mix of ‘not our job’ and ‘nothing to see here’.

‘For now, I don’t see any aspect of the situation that we really need to be concerned about’, insider two said, noting the better-than-expected increase in French GDP in 1Q. It was not the task of the ECB in any event to step into the breach in lieu of democratically elected officials, he insisted.

Pressed on what would happen if market turmoil worsened, insider two would say only that such a situation remained to be seen, with what had transpired so far easily within historical parameters.

‘There is absolutely no basis for the time being to talk about the TPI, which anyway comes with very clear conditions that simply do not correspond to the present situation’, he insisted.

Still, while initially resisting the idea that the ECB would respond to fragmentation in any event, insider two reluctantly conceded that if financial markets really were to fragment, then the ECB would indeed ‘see whether steps by us would be appropriate’.

Insider three said he was not thinking in terms of the TPI, given that ‘nothing unusual has occurred’. That applied to talk of PEPP reinvestments as well, he made clear. ‘There is not even anything there to discuss’, he said. ‘So far, what we’ve seen is mainly just the media speculating rather than substantive developments.’

As for how the ECB would respond to a sudden change in the mood of the market that forced monetary authorities to think harder about France, ‘then you have to see why it has happened’, insider three said.

Insider four said he was not worried about France for the simple reason that monetary policy transmission remained unhampered and there were no obvious reasons to think this would cease to be the case.

There was therefore no room for ECB involvement in general, he said, and mention of the TPI in particular elicited an emphatic denial. ‘We have a full set of tools to deal with it if markets were to become disorderly’, he said. ‘But we are not now in a situation where we could think for a second that these things are actually needed.’

But as in the case of most of his peers, this insider too conceded that in the event of fragmentation, the ECB was ultimately likely to do something. PEPP reinvestments were an unlikely candidate, he said, given their limited remaining life.

Of the above insiders, one suggested that the France’s National Rally had modified its platform in a way that could assuage initial financial market concerns, as the changes indicated a healthy understanding on the party’s part that its initial proposals would have led to disaster.

One of the other insiders, noting that a hung parliament seemed the most probable outcome of the second round of elections, slated for this Sunday, suggested that this could work to the country’s fiscal benefit, as it would make an ambitious increase in the budget less likely.