ECB: ‘Camp’ for sudden market correction

Uncertain is the recovery of the economy in , according to the Financial Stability Report published today (20.11.2024) by (ECB). The ECB provides risks to banks, as the failure to address credit risk in certain Eurozone households and businesses could lead to a weakening of their asset quality if the negative scenario for growth is finally confirmed. In addition, the ECB warns that high valuations, combined with the general risks, make markets more vulnerable to sudden adjustments. As stated in the Report, while financial markets have proved to be durable, so far there is no room for complacency. The underlying vulnerabilities make the stock and corporate credit markets prone to further volatility. High valuations and risk concentration, especially in stock markets, increase the chances of sharp adjustments. In particular, with regard to banks, the ECB notes in the Report that high lending costs and weak growth prospects continue to burden corporate balance sheets, with euro area companies reporting a decrease in their profits due to high interest payments. The prospects for real estate markets are mixed, with housing prices stabilised, while commercial real estate markets are still under pressure due to the challenges posed by distance work and electronic commerce. Households, on the other hand, benefit from the strong labour market and have strengthened their resilience by increasing savings and reducing debt. Although the overall increase in credit risks is so far gradual, small and medium-sized enterprises and households with lower income could face pressure if growth is slowed down more than is currently expected, which could, in turn, adversely affect the quality of banks’ assets. The losses from the exposures of credit institutions to commercial immovable property, as the ECB estimates, risk further increasing and could be significant for individual banks and investment funds. Overall, however, the ability of banks to absorb further deterioration of the quality of assets remains supported by high levels of profitability and strong capital and liquidity reserves. With regard to developments on the public debt front, the report stresses that despite a reduction in the ratio of public debt to GDP after ejecting during the pandemic, fiscal fundamentals remain weak in some euro area countries. Public debt service costs are expected to continue to increase, as debt ending is passed on at rates higher than that of outstanding debt. Increased debt levels and high government deficits, combined with weak long-term growth prospects and policy uncertainty, increase the risk that fiscal diversion will revive market concerns about the sustainability of public debt. Source: RES – ICM