ECB Says Higher Yields Could Trigger New Debt Concerns

(Bloomberg) -- The European Central Bank said debt-sustainability concerns have risen in the past six months amid a potential increase in yields and political uncertainty in some countries.

“Risks to financial stability stemming from financial markets remain significant,” the Frankfurt-based institution said in its Financial Stability Review. An abrupt bond-market repricing could “materialize via spillovers from higher yields in advanced economies, in particular the United States.”

The Federal Reserve has raised interest rates twice since late last year and policy makers predict two more hikes in 2017 as the economy improves. In Europe, an exit from unconventional stimulus is also moving closer, even though officials caution that quantitative easing must be unwound very gradually before higher borrowing costs should even be discussed.

The ECB also warned in the report that euro-area banks remain vulnerable as low interest rates and a big stock of non-performing loans in some regions challenge profitability. It sees structural challenges in the industry, including overcapacity and too little income diversification.

In Italy, which has one of the euro region’s highest debt ratios and where the government is trying to finalize a plan to rescue Banca Monte dei Paschi di Siena SpA, business lobby Confindustria said on Wednesday that the country must “be ready for when the ECB will end sovereign bond purchases.” This means “quickly lowering the mountain of public debt through privatizations and sale of state-owned real estate,” Chairman Vincenzo Boccia said in Rome.

The ECB report acknowledged that Brexit “contributes to prevailing political uncertainties,” but said the impact on financial stability should be limited as long as banks take proper action in time. It sees a low risk of the euro-area economy facing restrictions in accessing financial services after Britain’s departure from the European Union.

“Well-managed preparations will be essential as a relocation of financial services capacity during the transition from the current situation to the new equilibrium could, in some cases, face frictions,” according to the report. “Therefore, the ECB underlines the need for the concerned banks and other financial institutions to undertake all the necessary preparations in a timely manner.”

ECB Vice President Vitor Constancio reinforced that view in comments posted on institution’s Youtube channel, saying that Brexit “can really not harm significantly the ongoing recovery in the euro area."

It’s “very significant for the U.K., but in view of the relative size it’s much less meaningful for the rest of the EU,” he said.

--With assistance from Lorenzo Totaro

To contact the reporters on this story: Jana Randow in Frankfurt at jrandow@bloomberg.net, Paul Gordon in Frankfurt at pgordon6@bloomberg.net.

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Zoe Schneeweiss, Lucy Meakin