The ECB's Financial Stability Report Is Scary Reading

Christine Lagarde has a critical meeting of the European Central Bank’s governing council coming up on June 10. As usual this will encompass a quarterly review of inflation and growth forecasts, an exercise that lets the ECB take stock of the impact of its monetary policy measures. But this time the gathering will also be a serious test of ECB President Lagarde’s ability to quell the hawkish rumblings on the council. 

Several governing council members are wondering — unwisely — whether to taper the central bank’s 1.85 trillion-euro ($2.3 billion) pandemic bond-buying program as Europe’s economies begin a staggered reopening.

The ECB’s publication on Wednesday of its yearly Financial Stability Review will be a useful weapon for Lagarde when pressing her argument that now is not the time to start easing back on stimulus. Indeed, the report makes for some scary reading as it lays out how vulnerable the euro area is to a number of significant challenges, as my Bloomberg News colleagues detail.

Some of these potential problems are beyond the ECB’s control, such as a spike in U.S. bond yields or a sharp fall in equity prices. That doesn’t mean it shouldn’t prepare for them. The review’s authors have looked at the possible impact of a 10% drop in the U.S. stock market on overall financing conditions, and assessed that it could be equivalent to a third of the effect of the pandemic itself. That would be a big enough shock to derail any nascent economic recovery in the European Union.

The ECB's Financial Stability Report Is Scary Reading

Keeping the monetary wagons rolling is doubly important at a vulnerable moment for the euro zone’s weakest link: Italy. This is a battle in which Lagarde must prevail as Europe’s fiscal cavalry has yet to turn up. The deployment of the EU’s 750 billion-euro pandemic recovery fund, agreed last summer, is still several months away. The EU’s job recovery fund, SURE, issued the last of its bonds this week so there will be a significant drop in external support for the most-pressed European nations over the summer.

This is the crunch point for ensuring the recovery. If the Bank of England and the U.S. Federal Reserve are confident that rising inflation will be temporary — allowing them to keep the quantitative-easing taps on — it seems hard to believe the ECB can’t look through this too. Core euro area inflation has failed to reach the “below but close to 2%” target for all of the last decade. Deflation remains the ECB’s biggest problem and it mustn’t lose sight of that. EU growth forecasts are substantially lower than those of the U.S. or U.K.

The ECB's Financial Stability Report Is Scary Reading

Frederik Ducrozet, a strategist at Banque Pictet & Cie, points out that the recent rise in yields should call for more not less ECB bond buying as borrowing conditions have tightened for Italy and other euro-area members. The governing council isn’t considering this option but Lagarde does have all the justification she needs to ensure the central bank stays the course and makes the full deployment of pandemic relief.

The recent surge in the India variant of Covid-19 shows this crisis isn’t over yet. Neither should the stimulus waver.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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