High Debt Levels Endanger Europe Through “unfavorable Shocks”, Warns the ECB - Latest Global News

High Debt Levels Endanger Europe Through “unfavorable Shocks”, Warns the ECB

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European countries are “vulnerable to negative shocks” from geopolitical tensions and persistently high interest rates because they do not further reduce their public debt, the European Central Bank has warned.

In its biannual financial stability review, the ECB said many European governments had not fully withdrawn support measures introduced to protect consumers and businesses from the impact of Covid-19 and the war in Ukraine.

It has been argued that the combination of “high debt and dovish fiscal policies” could spook investors. This, in turn, could “further increase borrowing costs and have negative impacts on financial stability, including through spillover effects on private borrowers and government bondholders,” it said.

She also warned that markets could react to the risks of “fiscal misstep” ahead of elections expected this year and next, including in the European Parliament, Germany, Austria and Belgium.

The ECB said risks to the financial system had largely abated in recent months and household and corporate debt had fallen below pre-pandemic levels. However, she added that public debt was likely to remain high, citing “lax fiscal policy” as a key concern.

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While economic activity is expected to pick up over the next few years, supported by robust labor markets, lower inflation and expected ECB interest rate cuts from next month, it said there are “structural challenges”. . . remain an obstacle to productivity and growth.”

Amid signs of increased losses in commercial property, the ECB said the “outlook remains fragile” and “financial markets remain vulnerable to further negative shocks”.

It argued that anticipation of impending interest rates had “boosted investor optimism” but warned that “sentiment could change quickly.”

Line graph showing that there are more and more deteriorating commercial real estate loans in Europe

The ECB’s warning came after the EU published updated economic forecasts in which it estimated that euro zone governments’ net debt would rise from 3.6 percent of GDP last year to 3 percent this year and 2.8 percent in 2025 would sink.

However, it is expected that the state’s total debt will remain above pre-pandemic levels at 90 percent of GDP across the bloc in 2024 and will rise slightly next year.

The ECB has sought to give additional teeth to the EU’s new fiscal rules by warning that any countries that do not adhere to Brussels’ recommendations to reduce debt under the excessive deficit procedure will be excluded from the central bank’s new but untested bond-buying program could become.

Brussels noted that up to 11 EU countries, including France and Italy, were expected to be reprimanded for breaches of the 3 percent budget deficit limit under revised fiscal rules that came back into force this year.

However, ECB Vice President Luis de Guindos said on Thursday that this issuance would be examined under its so-called transfer protection instrument, which allows it to buy bonds of any country found to be experiencing an unjustified increase in borrowing costs.

“We will go beyond and go beyond the terms of a particular country’s excessive deficit procedure,” he said.

Borrowing costs for European governments have fallen from recent highs as investors expect the ECB to soon begin cutting interest rates in response to falling inflation, which is now close to its 2 percent target.

The spread between Italy and Germany’s 10-year borrowing costs – seen as an indicator of financial stress – has fallen almost to a two-year low.

However, the ECB said: “Uncertainties over the precise implementation of the new EU fiscal framework could lead market participants to reassess sovereign risk.”

Commercial property markets have suffered a “sharp downturn”, the ECB warned, adding that prices for office buildings and retail properties could fall further due to “structurally lower demand”.

The ECB sets monetary policy for the 20 member states of the euro zone and oversees the currency bloc’s largest lenders. It said the euro zone banking system was “well equipped to withstand these risks given its strong capital and liquidity positions.”

However, it warned that “inadequate liquidity buffers” could lead to “forced asset sales” by real estate investment funds, “particularly if the downturn in the real estate market continues or intensifies.”

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