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Financial News: ECB Says Risk Of Return Of Debt Sustainability

ECB Says Risk Of Return Of Debt Sustainability Concerns Increased

05/24/2017 - 08:49:00 (RTTNews)

(RTTNews) - Eurozone financial market stress remained contained in the past six months, though the risk of further bond market repricing remains and the risk of a return of concerns over debt sustainability has risen, the European Central Bank said in a report released on Wednesday.

Further, the ECB warned that excessive exuberance in regional house prices, in particular in capital cities, could have spillover effects into the national level and this warranted close monitoring especially in a low interest rate environment.

"Risks to financial stability stemming from financial markets remain significant, mainly owing to the possibility of a further rapid repricing in global fixed income markets," the ECB said in its latest Financial Stability Review.

"Such an abrupt repricing could materialize via spillovers from higher yields in advanced economies, in particular the United States."

The ECB drew attention to the further upward revisions of Federal Reserve monetary policy expectations as a key factor that can push long-term yields higher.

Other triggers could be a prolonged period of elevated political uncertainty or higher-than-expected euro area inflationary pressures causing investors to anticipate a faster normalization of monetary policy conditions, the report said.

The bank said there are risks that euro area bond yields could increase abruptly without a simultaneous improvement in growth prospects. A potential repricing in euro area bond markets may lead to substantial capital losses for investors with large exposures to fixed income instruments, the report warned.

The central bank also cautioned about significant vulnerabilities for euro area banks such as the challenge to profitability from low interest rates and large stocks of non-performing loans. These are in addition to structural challenges including overcapacity, less income diversification and cost-inefficiencies.

"Risks to euro area sovereign debt sustainability have increased over the past six months," the ECB report said.

"In recent weeks, however, euro area spreads narrowed and sovereign stress conditions improved somewhat following the result of the presidential election in France."

Regional developments in house prices could have "ripple effects" for the entire country or adjacent locations and could signal a potential build-up of vulnerabilities in housing markets at the national level, the ECB said in the report.

"Regional house price developments could pose challenges in the medium term when accompanied by a strong growth of mortgage loan financing amid weaker lending standards," the bank said in the report.

The bank cited Austria, Germany, France, the Netherlands, Estonia and Ireland as examples where house prices grew faster or declined less in capital cities than at the national level in recent years.

"Although diverging developments at the regional level could be justified by fundamentals, such as differences in regional income, employment, population dynamics and amenities, they could also signal excessive exuberance of house prices in certain areas, for example due to the strong presence of foreign buyers," the bank said.

A close monitoring of regional residential real estate price trends seems warranted, the bank added, more so in the context of a low interest rate environment spurring a potential search for yield.

"Exuberant house price developments in certain regions could, in principle, threaten the stability of financial institutions with mortgage exposures concentrated in those regions," the ECB said in the report.

There was no clear evidence of convergence across or within euro countries, the ECB said. The bank also noted that the price increases in selected capital cities with estimated overvaluations, including Berlin and Vienna, were more moderate than developments previously experienced in capitals where house price exuberance was followed by a correction, such as Madrid and Amsterdam.

Meanwhile, the "Brexit" process was currently not one of the main concerns for euro area financial stability, the report said. However, the ECB urged banks and other financial institutions to implement transition plans to cope with the event in a timely manner.

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