ECB Warns Of Corporate Weakness Amid Inflation, Slow Growth

The European Central Bank has warned that some companies in the euro area are at greater risk from a combination of rising commodity prices and lower economic growth due to Russia’s invasion of Ukraine.

As the struggle continues and monetary stimulus has been withdrawn to tackle record inflation, the region’s financial system needs to prepare for the prospect of another recovery in asset markets, officials said in their biennial Financial Stability Review published on Wednesday. needed.

“The terrible war in Ukraine has brought enormous human suffering,” ECB vice-president Luis de Guindos said in a statement. “It has also increased financial stability risks through its impact on almost all aspects of economic activity and financial conditions.”

Russia’s attack in late February pushed up commodity prices, denting trust between businesses and consumers, undermining the rebound from pandemic restrictions.

With ECB officials still determined to begin raising interest rates in July, debate has shifted from the time of lift-off to the pace at which policy should change in the coming months.

According to the European Commission, economic growth projections have been downgraded this year, while inflation in the currency bloc of 19 countries averages more than 6 percent.

The ECB said this environment poses a particular challenge for companies – including air transport, housing, food and beverages – that have never recovered from the COVID-19 restrictions.

“These vulnerabilities are compounded by the potential for tighter financing conditions that will adversely affect the debt servicing capacity of particularly low-rated firms,” ​​the report said.

The prospect of war and tighter monetary policy in Ukraine has contributed to a sell-off in stock markets, with major indices in the region falling more than 10 pc since the start of the year.

The ECB said further declines cannot be ruled out as the struggle continues.

“Despite the recent asset price correction, valuations remain elevated in light of the decline in macro-fundamentals, and further sharp corrections are a risk,” according to the report.

“Such reforms could be triggered by war escalation, emerging market tensions or persistent inflation higher than currently projected, which could prompt rapid monetary policy normalization by major central banks.”

Officials also warned of vulnerabilities in the euro area housing sector, where prices jumped at the fastest pace in 20 years in the last quarter of 2021 – helped by lower rates, changing priorities due to the pandemic and high input costs.

“While tight supply conditions and continued demand among households and investor preference for housing are easing home price pressures, signs of overvaluation leave some housing markets prone to price corrections,” it said. .

While the ECB cautioned that banks could be indirectly affected by the war and its effects on supply chains and commodity prices, the analysis shows they are “resilient to the effects of a second round” of the conflict.

In a portion of the report published earlier this week, officials also warned that the dramatic jump in the size and complexity of crypto markets means that the sector is well on its way to becoming a risk that must be regulated immediately.

While the recent volatility hasn’t proved contagious to the rest of the financial system, the risk is growing with the rapid involvement of institutional investors, he said.