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ECB: The new risks to the economy and banks

By Leonidas Stergiou

Inflation threatens fragile growth in the Eurozone as bond yields rise, with a direct negative impact on borrowing costs, bond and portfolio valuations, and government debt, especially at a time when fiscal pressures are being exacerbated by its measures. . At the same time, ECB research shows a reluctance to turn increased deposits into investment and consumption, while the risks to the real economy from the pandemic remain. Add to this the worrying signs of a bubble in the real estate market in some member countries, which does not include Greece.

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The growth rate surprised positively in the first two quarters of 2021 and remains marginally up to 0.5% in the third quarter, according to the ECB Financial Stability Report. However, there is a slower growth rate, mainly as a result of inflation and supply chain problems. The uncertainty for a new outbreak of the Covid pandemic and the signs of a slowdown in China are aggravating. Nevertheless, real GDP is very likely to close in 2021 at higher levels before the pandemic, mainly due to the sharp rise in the first two quarters.

In this environment, the new risks to the economy and banks, according to the ECB, are:

First, the outbreak of the pandemic. According to the ECB, different vaccination rates and cases between Eurozone countries hinder smooth growth. Some of the sectors hardest hit by the pandemic, such as tourism and transport, have not returned to pre-covid levels, while some countries do not see a recovery to 2019 levels before the second half of 2022. The main indication of this is the slowdown in private sector expectations in the face of a new wave of pandemics and new lockdowns.

Second, the forecasts for a slowdown in China’s economy, combined with problems in international transport and the supply chain, are creating a dangerous mix in the growth of the Eurozone. The “key” to this development will be the demand for European products and services from China.

Third, the increase in budget deficits due to support packages has had a modest effect on public debt so far. However, rising yields or rising interest rates due to inflation may force governments to pursue a restrictive policy in 2022. This risk mainly affects countries with high public debt as a percentage of GDP, such as Greece. However, the ECB, in its report, seems to see the risk of tight fiscal policy in 2022 across Europe as real, halting growth. However, high inflation gives more room for fiscal adjustment with less impact on growth. In addition, governments still enjoy negative interest rates and the opportunity to issue long-term debt. On the positive side, the positive effects of the Recovery Fund and the other Structural Funds are recorded. The ECB considers that there is no visible debt risk in the short term, however this may not be the case in the medium term.

Fourth, increased household deposits are likely to be ultimately difficult to consume as they are held back due to uncertainty and to meet future needs, such as price increases, tax increases, etc. According to ECB research, aid distribution and deposits was not isomeric. Thus, deposits in high-income households, which consume anyway, have increased, so no higher consumption is expected due to deposits. Most deposits of high-income households were invested in real estate and other non-liquid assets, while those with lower incomes continue to rely on government measures. At the same time, the debt of households is increasing despite the reduction of its service costs.

Fifth, business and banking profitability is improved by removing short-term risks. However, profitability can be threatened by rising interest rates and declining real returns (returns less inflation). According to the ECB, a 1% increase in interest rates could lead to a 9% drop in profits, mainly through the valuation of bond portfolios. The outbreak of the pandemic remains a threat. Already, the yield on the German 10-year bond has risen from 0.99% at the beginning of 2020 to 1.79%. However, the real return due to rising inflation has fallen to 2.09% from 1.17%.

Sixth, the ECB has been warning for months about worrying rise in property prices in some countries. According to the valuation model used by the ECB, housing markets in Germany and France are under surveillance due to strong bubble signs, followed by those in the Netherlands, Belgium and Luxembourg. Austria is in the markets with a big increase in 2021, however it does not show any signs of concern at the moment. For the Greek real estate market, the ECB does not issue any recommendations or risk warnings to households, banks and the construction industry. In fact, it is among the countries with the lowest valuations. This is mainly due to the large reduction that preceded the pandemic. In the same category are the real estate markets of Malta, Ireland, Cyprus and Spain. Despite small price increases in Finland and France, the ECB has put them under surveillance as it detects signs of a bubble that started before the pandemic.

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Source From: Capital

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