ECB promises ‘cautious’ balance sheet reduction as stability risks rise

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FRANKFURT, Nov 16 (Reuters) – Risks to financial stability in the euro zone are growing as the economy heads into a likely recession, so any reduction in European Central Bank bond holdings should be gradual to maintain the calm of the markets, declared the vice-president of the ECB. said Luis de Guindos.

Soaring energy costs have increased the likelihood of a recession to 80% and a rise in interest rates intended to curb price growth is already fueling market volatility and rising utility costs. debt.

“Risks to financial stability in the euro area have increased amid soaring energy prices, high inflation and weak economic growth,” the ECB said in a biannual financial stability review on Wednesday. “All of these vulnerabilities could deploy simultaneously, potentially reinforcing each other.”

A potential stress for the markets will be a reduction in the ECB’s €3.3 billion asset purchase program next year, but de Guindos said any reduction in the bank’s stack, mainly of public debt, will likely be progressive and “passive”, meaning some bonds will be allowed to expire but none will be sold.

“My personal view is that (quantitative tightening) needs to be implemented very carefully,” de Guindos told a news conference.

“QT exercise is much trickier because we have more limited experience than with rate escalation, so I think we will start, and this is my personal view, with passive QT “said de Guindos.

The bloc’s banking sector is generally seen as resilient, having built up capital over the years and benefiting from increased profitability thanks to rising interest rates.

But there is potential for longer-term problems as economic challenges eat away at income, which can limit borrowers’ ability to repay debt. Lenders also face higher costs and weaker loan growth as the economic outlook deteriorates.

“While the banking sector has recently seen a recovery in profitability with rising interest rates, there are emerging signs of deteriorating asset quality, which may require larger provisions,” the ECB added.

To add to the list of worries, the ability of governments to keep spending down is also quite limited and many are providing broad support to households to cover the cost of soaring energy costs, creating ‘pockets’ of trouble. debt sustainability.

“High levels of public debt as a result of the pandemic, coupled with tighter financing conditions, limit the scope for fiscal expansion measures that do not trigger risks for

debt sustainability,” the ECB added.

All of these factors increase the risk of a disorderly adjustment in financial markets with potential repercussions for the rest of the economy.

While household debt worries are currently mostly confined to low-income borrowers, a turnaround in the housing cycle with falling prices could deepen vulnerabilities.

Reporting by Balazs Koranyi; Editing by Elaine Hardcastle and Toby Chopra

Our standards: The Thomson Reuters Trust Principles.

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