LIVE MARKETS-The French debt selloff could slow ECB hikes

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THE FRENCH DEBT SELLOFF COULD SLOW ECB HIKES

Market pricing currently sees an October rate hike by the European Central Bank as roughly a coin toss but Citi reckon the recent sharp selloff in French debt could mean the ECB will prefer to hold pat.

Their route to this conclusion is a touch involved, but bear with us and we can get there.

The context, of course, is the gap between German and French 10-year yields, which surged above 100 basis points last week and is up again today at 111 bps.

This is partly on the back of worries about French politics and a potential run-off election between the hard right and hard left but Citi also notes that since August French OATs have been the most sensitive to ECB rate pricing, even more so than Italian BTPs.

They said this suggests "ECB rate hike expectations may have crossed a threshold that leads the market to hone-in on (French) debt servicing implications."

That has broader implications, since, they say, if the French selloff continues it raises the potential the ECB uses its Transmission Protection Instrument (TPI).

This allows it to buy an unlimited number of bonds from any euro zone country experiencing a disorderly and unwarranted tightening of its financing conditions.

The problem is using TPI isn't a good look, particularly if it ends up being seen as the ECB bailing out profligate French fiscal spending.

"The general sense is that the ECB hopes to never use TPI," say Citi.

"It can make the prospect less likely by a moderate approach to hikes in response to a global energy shock it can do nothing about. One side product of this, we suspect, is that the ECB is unlikely to deliver a back-to-back hike in October."

(Alun John)

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