ECB warns of political threats to Eurozone financial stability

europeThe European Central Bank has warned global political uncertainty risks could, in a worst case scenario, reignite the 2009 debt crisis in the Eurozone.

The bank said the Brexit vote and the US election, as well as higher inflation and rising interest rates, is likely to systemically impact the Eurozone and increase asset price volatility.

In its Financial Stability Report, published today, the bank says: “Higher political uncertainty may lead to more domestically focused, growth-hindering policy agendas.

“This, in turn, could delay much-needed fiscal and structural reforms.”

It adds higher political uncertainty has contributed to periods of “elevated asset price volatility”.

The report says: “The improved market sentiment in the weeks after the UK referendum benefited from a timely and forceful response by the Bank of England, which cut the bank rate and introduced a package of measures designed to provide additional monetary stimulus.”

The euro area government debt-to-GDP ratio is projected by the European Commission to stand at close to 90 per cent of GDP in 2017.

The report adds: “The implications of the recent US election for euro area financial stability are highly uncertain at the current juncture.

“This notwithstanding, economic policies in the United States will likely become more inward-oriented, while the fiscal deficit may grow as a result of tax reductions and increased infrastructure and defence spending.

“In such a scenario, the euro area economy may be impacted via trade channels and by possible spillover effects from higher interest and inflation rate expectations in the United States.”

The bank also warned on market falls, both for equity and bond investors.

It says: “Valuation measures– including the cyclically adjusted price to earnings ratio are in some regions hovering at levels which, in the past, have been harbingers of impending large corrections.”

The bank said if volatility is “highly persistent” as during the global financial crisis, shocks to financial market sentiment are “long lasting”, the central bank intervention in monetary policy would continue.