Risks to euro area economic growth have shifted to the downside as inflation has moved closer to 2 per cent, while financial markets have experienced several pronounced but short-lived spikes in volatility in recent months.
“The outlook for financial stability is clouded by heightened macro-financial and geopolitical uncertainty together with rising trade policy uncertainty,” said ECB vice president Luis de Guindos in a release.
The European Central Bank sees elevated financial stability vulnerabilities in a volatile environment, its November Financial Stability Review says.
Economic growth is fragile, while concerns about global trade outlook add to geopolitical and policy uncertainty.
Weak fiscal fundamentals in some nations and sluggish potential growth raise concerns about sovereign debt sustainability.
While financial markets have proved resilient so far, there is no room for complacency. Underlying vulnerabilities make equity and corporate credit markets prone to further volatility, the report notes.
High valuations and risk concentration, especially in equity markets, increase the odds of sharp adjustments. Should adverse dynamics materialise, non-banks could amplify market stress given their liquidity fragilities, in some cases coupled with high leverage and concentrated exposures, it says.
Despite the decline in sovereign debt-to-gross domestic product (GDP) ratios after the surge during the pandemic, fiscal fundamentals remain weak in some euro area countries.
Sovereign debt service costs are expected to continue rising as maturing debt is rolled over at interest rates that are higher than those on outstanding debt.
Elevated debt levels and high budget deficits, coupled with weak long-term growth-potential and policy uncertainty, increase the risk that fiscal slippage will reignite market concerns over sovereign debt sustainability, the ECB report says.
High borrowing costs and weak growth prospects continue to weigh on corporate balance sheets, with euro area firms reporting a decline in profits due to high interest payments.
Commercial real estate markets are still stressed because of challenges posed by remote working and e-commerce.
While the overall increase in credit risks has so far been gradual, small and medium companies and lower-income households could face strains if growth slows by more than is currently expected, which could, in turn, adversely affect the asset quality of euro area financial intermediaries.
Losses on commercial real estate exposures are at risk of rising further and could be significant for individual banks and investment funds.
In aggregate, however, banks’ ability to absorb further asset quality deterioration continues to be supported by high levels of profitability and by strong capital and liquidity buffers, the report adds.
Fibre2Fashion News Desk (DS)
