The reliance of the eurozone’s financial system on the policies of its central bank have been laid bare in the European Central Bank’s latest financial stability review, which highlights the risks posed by attempts to rein in extraordinary monetary stimulus.
Policymakers look set to begin a discussion over the course of the summer on tapering a quantitative easing programme, under which they are now buying €60bn-worth of mostly government bonds a month. While stronger growth in the region supports the case for reining in monetary support, some on the ECB’s governing council are concerned that moving too quickly towards the exit will trigger a market panic.
While it does not name the ECB’s actions specifically, the latest financial stability review argues that there is a threat that a change in market expectations about economic policies could trigger a violent reaction in bond prices.
That in turn could trigger a panic about some eurozone sovereigns’ and companies’ ability to meet their obligations.
“A gradual normalisation of euro area bond yields taking place in tandem with improved economic growth prospects would be beneficial from a financial stability perspective,” the report said. “There are, however, risks that euro area bond yields could increase abruptly without a simultaneous improvement in growth prospects.”
This would lead to “substantial” capital losses for big debt holders. Higher borrowing costs for euro governments could also exacerbate what the ECB said was a rising threat posed by concerns over public and private debt sustainability. “Even though headline yields on euro area sovereign debt have fallen somewhat, this masks the fragility of public finances in some countries,” the report said.
The review said there was — as yet — little risk to euro area financial stability from Brexit.