France’s central bank boss says UK crisis shows risk of ‘vicious loop’


The head of France’s central bank has warned that the recent turmoil in UK bond markets illustrates the “vicious circle” facing governments as they undermine the efforts of rate setters to curb rising inflation.

François Villeroy de Galhau, who sits on the European Central Bank’s board of directors for setting interest rates, said in an interview that the sharp rise in the cost of borrowing from the British government after it paid £45 billion last month unfunded tax cuts revealed the importance of “a consistent policy mix” between central banks and lawmakers.

The governor of Banque de France underlined the risks of fiscal expansion at a time of rapidly rising interest rates: “If you pursue a monetary policy with an anti-inflationary stance and there are doubts that your fiscal policy will fuel inflation, then really the risk run to feed a vicious circle.”

The sell-off of government bonds forced the Bank of England to intervene to halt the collapse of parts of the UK pension sector. The governor of the Banque de France warned that this was the latest example of the vulnerability of the non-bank financial sector to cash shortages.

He urged global regulators at the Financial Stability Board to “put in place clearer and stricter rules now” to ensure funds and traders build stronger liquidity buffers. “We need more data and in every jurisdiction we need some sort of liquidity stress test,” he said.

Comparing the turmoil in the UK to the panic in money market funds after the Covid-19 pandemic hit in 2020 and a shortage of collateral among energy traders after Russia invaded Ukraine in February, Villeroy said: on the liquidity of non-banks.”

The British government reversed Monday after new Chancellor Jeremy Hunt announced he would scrap two-thirds of the tax cuts announced by his predecessor Kwasi Kwarteng, who was fired on Friday.

Villeroy laughed in disbelief at recent events in the UK, which he said had dominated the IMF and World Bank annual meetings in Washington last week, and said he didn’t expect major euro area governments to repeat the mistake.

While governments in the currency bloc have not experienced the turmoil in the UK in recent weeks, they are spending a lot of money to cushion the blow of rising energy prices for businesses and households. Economists, including those at the IMF, believe the energy packages increase the risk of high inflation becoming entrenched.

Villeroy, however, said the measures were “understandable”. France’s energy price cap, with limited electricity price increases to 4 percent this year and frozen domestic gas prices, had helped keep inflation at a more manageable 6.2 percent — the lowest in the eurozone — so far. “As far as these measures remain targeted and temporary — and time will tell — they are quite useful.”

The ECB raised interest rates by 1.25 percentage points this summer to counter the record high inflation rate of 10 percent – ​​five times the target of 2 percent – ​​and will raise the deposit rate by 0.75 percentage points to 1.5 next Thursday. per cent.

French President Emmanuel Macron told Les Echos in an interview published Monday that he was concerned about the view that demand had to be “destroyed” by aggressive monetary tightening “to better contain inflation”.

Villeroy declined to comment on Macron’s concerns. But he expressed annoyance at the idea that the ECB risked pushing the economy into recession, saying this “misses the point”. The ‘predominant’ risk was not higher interest rates, but the energy crisis.

The ECB would continue to “go fast” until its deposit rate reached 2 percent at the end of the year – the so-called neutral rate at which it does not stimulate or constrain the economy. Any increase after that point would be at a “more flexible and slower pace,” he said.

The ECB wants to start shrinking its balance sheet of €9 billion that has exploded during the pandemic once interest rates are neutral. Villeroy said the bank could stop replacing some of the bonds maturing under its €3.26 trillion asset purchase program from the end of this year.

To do that, private lenders should be encouraged to repay the €2.1 trillion in ultra-cheap loans the ECB has provided under its targeted longer-term refinancing operations (TLtro), he said.

The TLtros are designed to encourage lenders to keep borrowing during the pandemic by providing them with financing at minus 1 percent. However, due to rising interest rates, lenders are now lining up for a risk-free profit of more than €25 billion.

Shrinking the balance sheet would be handled with care, he said. “Clearly but gently, let’s start off and then gradually accelerate.”