The sharp rise in interest rates since last July to contain inflation in the euro zone could "reveal vulnerabilities" in the financial system, the European Central Bank warned in a report published on Wednesday. "As we tighten monetary policy to reduce high inflation, this can reveal vulnerabilities" by testing the resilience of companies, households and governments, ECB Vice-President Luis de Guindos said at the publication of the monetary institution's semi-annual report on financial stability. This is despite the fact that economic conditions have "improved slightly" and energy prices have recently fallen.
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The ECB has raised its key rates to an unprecedented extent, by 3.75 percentage points since last July, and intends to raise them further to bring inflation back to the 2% target, compared to 7% over one year in April. Among other visible effects of this policy, a correction in real estate markets that could "become disorderly" if the rise in mortgage rates "reduces demand more and more," notes the ECB. This report comes after the financial turmoil in March caused by bank failures in the United States and the forced takeover of Credit Suisse by UBS. "These events were a powerful reminder of the importance of ensuring that the fundamentals of the banking system are sound," says Mr. De Guindos in the introduction to the report.
Banks in the euro area are known to be strong and lending volumes are being reduced and funding costs are rising, which can affect their profitability. Signs of deterioration are visible in their loan portfolios exposed to commercial real estate, small business and other consumer loans, the report said. These institutions are also at the mercy of non-bank customers -- funds, insurers, clearing houses ... -- who represent 14% of their deposits, if these customers withdraw their assets in the face of a need for liquidity, warns the ECB. States are faced with rising financing costs, which come at a bad time when refinancing the mountain of public debt accumulated during the pandemic and then the surge in energy prices. "The outlook for financial stability in the euro area remains fragile," the report concludes.
