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The Eurozone risks another debt crisis if the bloc cannot boost growth, lower public debt and fix “policy uncertainty”, the European Central Bank has warned.
In its annual Financial Stability Review, published on Wednesday, the ECB sounded the alarm over a potential return of “market concerns over sovereign debt sustainability”.
It pointed to “elevated debt levels and high budget deficits” as well as tepid growth and uncertainties caused by recent “election outcomes at the European and national levels, notably in France”.
Spreads between French and German 10-year government bonds — a key gauge of investors’ concerns — this month rose to 0.77 percentage points, close to the 12-year high reached in the run-up to this summer’s parliamentary election.
“Headwinds to economic growth from factors like weak productivity make elevated debt levels and budget deficits more likely to reignite debt sustainability concerns,” the ECB warned on Wednesday.
More than a decade ago, Greece narrowly avoided a default after concerns about its financial stability fuelled market unrest over the common currency. This only subsided after then-ECB president Mario Draghi pledged to do “whatever it takes” to prevent a collapse of the currency area.
The ECB said on Wednesday that sovereign credit risk premiums could be pushed higher by macro-financial shocks, pointing to “weak” fundamentals in several member states and maturing sovereign debt being “rolled over” at higher interest rates.
It added the combination of low growth and high government debt in the 20-country currency bloc could make it more difficult for governments to pay for higher defence needs and investments to fight climate change.
The ECB also warned that stock and bond markets are exposed to rising risks of “sharp adjustments”, pointing to “high valuations and risk concentration” that had already resulted in “several pronounced but shortlived spikes in volatility”.
In a potential economic slump, bank balance sheets could also take a hit as consumers and companies in the Eurozone are already struggling with higher interest rates, it said.
The threat of higher losses on commercial real estate “could be significant for individual banks and investment funds”, the ECB added.