(Bloomberg) — Some companies in the euro area risk being overstretched by the combination of surging commodity prices and lower economic growth caused by Russia’s invasion of Ukraine, the European Central Bank warned.
The region’s financial system also needs to brace for the possibility of another correction on asset markets as the conflict continues and monetary stimulus is withdrawn to combat record inflation, officials said in their bi-annual Financial Stability Review published on Wednesday.
“The terrible war in Ukraine has brought immense human suffering,” ECB Vice President Luis de Guindos said in a statement. “It has also increased financial stability risks through its impact on virtually all aspects of economic activity and financing conditions.”
Russia’s attack in late February sent commodity prices soaring while denting confidence among businesses and consumers, damping the rebound from pandemic restrictions. ECB officials are still determined to start raising interest rates in July, with the debate shifting from the timing of lift-off to the pace at which policy should change in the coming months.
Projections for economic growth this year have been downgraded, while inflation in the 19-nation currency bloc is set to average more than 6%, according to the European Commission. That environment is a particular challenge for companies — including air transport, accommodation, food and beverages — that never properly rebounded from Covid-19 restrictions, the ECB said.
“These vulnerabilities are compounded by the prospect of tighter financing conditions that would adversely affect the debt servicing capacity of lower-rated firms in particular,” it said in the report.
The war in Ukraine and the prospect for tighter monetary policy have contributed to a sell-off on stock markets, with key indexes in the region down more than 10% since the start of the year. Further downward moves can’t be ruled out as the conflict drags on, the ECB said.
“Despite recent asset price corrections, valuations remain stretched in light of the deterioration in macro-fundamentals, and further sharp corrections are a risk,” according to the report. “Such corrections could be triggered by a further escalation of the war, emerging market stresses or by more persistent inflation than currently foreseen, which might prompt faster monetary policy normalization by major central banks.”
Officials also warned of vulnerabilities in the euro area’s housing sector, where prices jumped at the fastest pace in 20 years in the final quarter of 2021 — helped by low rates, changing preferences because of the pandemic and higher input costs.
“While house price pressures are being buttressed in the near term by tight supply conditions and continued demand amid household and investor preference for housing, signs of overvaluation render some housing markets prone to price corrections,” it said.
While the ECB cautioned that the banks could be indirectly affected by the war and its impact on supply chains and commodity prices, analysis suggests that they’re overall “resilient to the second-round effects” of the conflict.
In a part of the report published earlier this week, officials also warned that the dramatic jump in the size and complexity of crypto markets means the sector is on track to become a risk that must urgently be regulated. While recent volatility has not proved contagious to the rest of the financial system, the threat is rising with institutional investors increasingly involved, they said.
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