The euro area’s strengthening recovery and monetary stimulus are making national debt burdens more sustainable, though the risk remains that political uncertainty could cause yields to spike abruptly, the European Central Bank said.
The Frankfurt-based institution said in its twice-yearly Financial Stability Review that stress in euro-area sovereign-bond markets has declined to levels seen before the financial crisis. The favorable developments were likely underpinned by reduced economic policy concerns in Europe following national elections in major countries, and a continuation of the ECB’s monetary support.
Even so, it said that “higher interest rates may trigger concerns about sovereigns’ debt-servicing capacity,” and noted that “distrust in mainstream political parties continues to rise, leading to fragmentation of the political landscape away from the established consensus.”
The ECB’s cautiously optimistic outlook comes against the background of the fastest economic growth in a decade for the euro area, bolstered by the prospect of continued monetary support. At the same time, it’s a reminder that the central bank’s recent decision to slow its bond-buying may be the beginning of the end for ultra-loose monetary policy.
The stance compares with concerns about investor complacency raised by Germany and Sweden in their own reports on financial stability earlier on Wednesday.
“Market participants have become more vulnerable to unexpected developments,” Bundesbank Vice President Claudia Buch said. “Risks stemming from revaluations, changes in interest rates and credit losses could materialize simultaneously and reinforce each other.”
Sweden’s Financial Supervisory Authority remarked that a strong economy and low interest rates create the conditions for an “abrupt” increase of yields of over-valued assets, especially in the real-estate sector.
The ECB also noted that a sudden repricing in global markets remains one of the three key “medium-level systemic risks,” together with the low profitability of euro-area banks, and public and private debt sustainability in some countries. None of these risks has increased since the last report in May.