The European Central Bank yesterday issued a warning of the threat posed by the scaling back of monetary stimulus in the US.

It called on the currency bloc's policymakers to prepare for the ill effects of Federal Reserve tapering.

The ECB said in its latest financial stability report that the risks to the euro zone’s financial system from outside the currency bloc had grown since May on the back of the Federal Reserve’s talk of tapering its $85 billion worth of monthly bond purchases, despite a general improvement in market conditions.

“Starting in May, there was a significant repricing in global bond markets, which took place largely because of changing monetary policy expectations in the United States – with increased foreign exchange market volatility and stress borne largely by emerging market economies,” the ECB said.

The ECB warned that, while the euro zone’s institutional investors were more exposed to bond markets than the region’s lenders, it was difficult to know where the risks of ultimate losses were greatest.

"It cannot be ruled out that ultimate exposures are concentrated among a limited number of entities which may now be more vulnerable to any further severe market shock," the ECB said.

Insurance companies
"Such losses are potentially compounded by an environment of historically low prevailing yields in some countries, which continues to constitute a risk for institutional investors such as insurance companies."

The ECB said weak bank profitability and persistent financial fragmentation still presented a threat to stability. Banking union would be "an important contribution" to resolving these hurdles.
– Copyright The Financial Times Limited 2013