ECB to warn of market correction risk this week

The European Central Bank’s semi-annual assessment of financial stability this week will highlight how threats to the region have increased yet again, vice-president Luis de Guindos said.

“Repricing risks and liquidity difficulties render financial markets and non-bank financial institutions vulnerable to disorderly risk adjustments,” Mr Guindos said in a speech in Frankfurt on Monday. “Investment funds’ liquid asset holdings remain low, and could thus amplify a market correction in a forced selling scenario.”

Mr Guindos, who oversees financial-stability analysis at the ECB, repeated the current mantra of officials about inflation risks and the need to keep raising interest rates. His speech focused on how market and liquidity threats have shifted, noting that a correction in prices since the Russian invasion has already been under way.

“So far this repricing has generally been orderly but market volatility increased, leading to knock-on effects for margins and liquidity,” he said. “Asset valuations remain sensitive to the uncertain path of inflation, to monetary policy normalisation and to economic activity.”

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Among the threats Mr Guindos identified are the impact of rising rates on bond portfolios. “This points to risks from further valuation losses, especially for leveraged and liquidity-constrained institutions,” he said.

Meanwhile banks, while more profitable than before, may face higher credit risk from vulnerabilities in real-estate markets, the vice-president added.

Officials have made it clear that the ECB should keep lifting borrowing costs even after 200 basis points of hikes since July. An increasing number sees a need to raise them to a level that constrains the economy, thought to start at around 2 per cent.

Monetary policy must “remain focused on reducing support for demand and guarding against the risk of second-round effects”, Mr Guindos said. “Amid the present uncertainty, future decisions on policy rates will continue to be data-dependent and taken on a meeting-by-meeting approach.”

His colleague, executive board member Fabio Panetta, sounded a more dovish note earlier on Monday, warning against “excessive tightening that could cause lasting damage to the economy”. – Bloomberg