Weak economic growth could cause euro area asset prices to fall and borrowing costs for indebted countries to rise, the European Central Bank (ECB) has today warned, posing a major threat to the zone’s financial stability.
The ECB’s May financial stability report comes during a period of slow growth for the euro area, which has struggled with global trade tensions, Brexit negotiations, and a weak recent performance by Germany, Europe’s biggest economy.
“If downside risks to the growth outlook were to materialise, risks to financial stability may arise,” said Luis de Guindos, vice president of the ECB. “The growth outlook is central to all the main risks to financial stability.”
A long period of low growth in Europe is likely to see borrowing costs for countries and companies with high debts rise significantly, which could “unearth debt sustainability concerns”, the ECB warned.
In a veiled swipe at Italy, the euro’s central bank said although public debt in the zone overall has fallen, it has “continued to increase in some of the highly indebted countries”.
Brussels and Rome have recently reignited their spat over Italy’s high levels of debt, with the country’s deputy prime minister Matteo Salvini yesterday calling on the ECB to “guarantee” countries’ debt to keep borrowing costs low.
Historically low interest rates have allowed firms with weak balance sheets to significantly increase their borrowing, today’s ECB report said. These companies could face severe problems rolling over their borrowing should their credit ratings be downgraded in a period of weak growth, it warned.
The ECB predicted bank profits to remain low in the Eurozone over the coming years, with average return on shares coming in at six per cent, below what many investors expect. “The low growth and interest rate environment could further dent profitability,” the ECB said.
Brexit also poses a risk to the Eurozone, the ECB said, despite preparations being made “where necessary”.
The Bank said a shock could occur if “a no-deal Brexit interacts with other global shocks”, although it would “would likely be concentrated on particular countries, such as those with significant ties to the UK”.