Christine Lagarde (R), President of the European Central Bank (ECB), and Vicepresident Luis de Guindos (L)
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Financial markets might face a sharp downturn within the occasion of any additional shocks to the worldwide economic system, European Central Bank Vice-President Luis de Guindos informed CNBC on Wednesday.
Earlier on Wednesday, the ECB revealed its May Financial Stability Review, saying that the euro space’s stability outlook remained fragile within the aftermath of current turmoil within the banking sector, which noticed the failure of a number of U.S. regional banks and the emergency takeover of Credit Suisse by UBS.
Although it decided that financial institution resilience in a larger rate of interest atmosphere was not a concern within the euro space, with fundamentals remaining stable and regulatory intervention proving efficient, the ECB mentioned it’s “potential that these occasions may lead to a reassessment of the profitability and liquidity outlooks for euro space banks.”
Global inventory markets made a sturdy begin to 2023, given falling vitality costs, China’s reopening and the stunning resilience of the euro zone economic system — driving fairness valuations again above historic averages, the ECB highlighted.
This reversed abruptly in late February and March as a hawkish tone from central banks and surprising stress within the banking sector roiled traders all over the world. De Guindos mentioned present market positioning rendered shares vulnerable to any additional macro surprises.
“There is the potential for a correction in markets, and the reason being that valuations are excessive, are elevated, and in case you have a look at, as an illustration, threat premia, they are fairly compressed, so simply in case that we now have unhealthy information with respect to the macroeconomic outlook, that might give rise to a correction of markets,” de Guindos mentioned.
The ECB report famous that the potential for “disorderly changes” in financial markets had spiked in opposition to a backdrop of tighter financial circumstances and decrease market liquidity. The banking sector turmoil of March led to a widening of credit score threat premia within the euro space, the central financial institution mentioned.
“By distinction, the truth that fairness threat premia stay compressed in absolute and relative phrases, particularly within the United States, raises considerations over potential overvaluation. Equities could thus be extra vulnerable to a disorderly value correction within the occasion of a additional deterioration within the financial outlook,” the report mentioned.
“As such, threat sentiment stays fragile and is very delicate to surprises as regards the outlook for inflation, progress and financial coverage in mature economies.”
This might take the type of extra persistent inflationary pressures, forcing central banks into “extra important” coverage tightening than the markets have presently priced in.
There are additionally dangers to the banking system from any fragility in non-bank financial establishments, de Guindos highlighted.
“We point out that interlinkages are related and are vital, so that you just can not immunize what occurs within the banking trade from the non-banking trade.”
The ECB report mentioned that, though the non-bank financial sector stays resilient for now, exposures to credit score threat stay excessive, opening it to “the chance of fabric losses ought to company sector fundamentals deteriorate considerably.”
“In addition, non-banks’ publicity to property markets has elevated markedly lately, rendering establishments vulnerable to ongoing property value corrections,” it mentioned.
“Strong hyperlinks with banks, as an vital supply of funding as an illustration, might additionally give rise to further vulnerabilities within the banking sector through liquidity and credit score threat spillovers.”