Il Nuovo Postiglione - France's debt woes in focus as ECB meets

The ECB is set to keep interest rates on hold, having already hiked them twice this year, walking a fine line between tamping down inflation fuelled by the Iran war energy shock and supporting the eurozone economy.

But the focus of Thursday's meeting is likely to shift quickly to France and "how the ECB will respond to the ongoing fiscal and political crisis," said Andrew Kenningham, chief Europe economist at Capital Economics.

French bond yields, which reflect the cost of government borrowing, surged to their highest level since 2002 last week amid a standoff over next year's budget, which aims to reduce the country's vast debts.

Concerns have also been fuelled after protests, driven in part by demands for more spending on public services, degenerated into the worst street violence in years.

There has been speculation that the ECB could, for the first time, use a crisis-fighting tool aimed at combatting sharp movements in markets to push down French bond yields.

However, the criteria to activate the so-called Transmission Protection Instrument (TPI) are strict, and most observers believe France's problems do not meet the threshold.

The ECB stipulates that the tool can only be used to counter "unwarranted" moves in markets, where there is a risk of financial stress spreading -- but not in cases where problems stem from poor fiscal policy.

So far ECB President Christine Lagarde, who also once served as France's finance minister, has sounded cool about the idea.

Asked about France's rising yields earlier this month, she responded: "The primary and first solution lies at home in France. And it has to do with fiscal policies."

France's central bank chief, who sits on the ECB's governing council, also downplayed the prospect of an intervention, saying that "conditions are not met" for the central bank to step in.

Kenningham of Capital Economics predicted there would be "no lifeline for France" at Thursday's meeting, saying spreads between French and German bonds, the eurozone benchmark, would need to widen far more to justify any action.

- Rates on hold -

Despite rising inflation caused by higher energy prices, the central bank for the 21 nations that use the euro is expected to keep its benchmark rate steady at 2.5 percent.

The ECB's rate call will come a day after the Federal Reserve announces its latest decision, with the US central bank also expected to stay on hold following a hike in September.

Eurozone inflation rose to a three-year high of 3.8 percent in September, although closely watched core inflation -- excluding volatile energy and food prices -- hardly changed.

There have so far been "very little knock-on effects from higher energy prices," ING economist Carsten Brzeski told AFP.

And France's crisis had "actually lowered chances of another rate hike," he said, adding that the "bond markets have taken over the ECB's task".

Rising bond yields cause tighter financing conditions and can push up borrowing costs for businesses and households, similar to the impact of higher rates.

Most economists predict the ECB will make the final hike of its current tightening cycle in December when it will be armed with updated growth and inflation forecasts.

Lagarde is also likely to face questions about her future as speculation intensifies she will step down before her term as ECB chief officially ends in October next year.

She has been linked to the top job at the World Economic Forum, which hosts a gathering of the global elite every year in the Swiss Alps resort of Davos.

But she has been tight-lipped so far, saying at the ECB's last meeting in September there was "nothing to report" on the matter.

A.Riccobono--INP