By Paul Hannon
The eurozone's financial system faces less acute threats to stability as it appears increasingly unlikely that the currency area's economy will slide into a deep recession, the European Central Bank said.
However, the central bank warned that geopolitical and policy uncertainty remains "elevated" and that the potential for economic or financial shocks remains "high."
"Geopolitical risks continue to cloud the outlook for financial stability," ECB Vice-President Luis de Guindos said Thursday.
"While financial stability conditions have improved in line with reduced recession risks and lower inflation, it remains crucial that we build further on the resilience of the financial system."
The surge in food and energy prices that followed Russia's invasion of Ukraine in early 2022 threatened to push the eurozone economy into a deep and prolonged contraction. Recessions can weaken banks and other financial institutions, since defaults on loans typically rise.
The eurozone economy did slip into a shallow contraction in the second half of last year, but return to growth in the first three months of 2024, and is expected to continue to expand.
But while that threat to financial stability has eased, anemic growth and higher interest rates continue to pose problems for banks, the ECB said in its latest report on the eurozone's financial system. It highlighted declines in property prices as a continuing drain on bank profits.
"The commercial segment in particular is continuing to experience a substantial price correction, and further declines cannot be excluded," the ECB said. "By contrast, residential property markets are showing some signs of stabilization after what has so far been an orderly price correction."
The ECB said expectations of lower interest rates as inflation cools have boosted investor sentiment. The central bank has signaled it will likely cut its key interest rate in June.
However, it warned that recovery in sentiment is fragile.
"Acute geopolitical stress could spark volatility, creating the potential for outsized market reactions that could be amplified by non-banks with structural liquidity fragilities," it warned.
Write to Paul Hannon at paul.hannon@wsj.com
(END) Dow Jones Newswires
05-16-24 0504ET
