The European Central Bank said in a biannual stability review that, the high debt levels and a property bubble are among Europe’s biggest economic vulnerabilities, weighing on its recovery from a pandemic-induced recession.
During the pandemic copious government subsidy kept much of the euro zone afloat. But weaning the bloc off support will be tricky. Because, that could boost bankruptcies and unemployment, which is a drag on growth and a risk to banks. The bank said that the governments face a delicate balance between prematurely adjusting support measures. This may contribute to triggering a wave of corporate insolvencies, and maintaining support measures for too long and thus keeping unviable corporates alive.
The ECB said that given that public debt has soared in the past year, the continued need for policy support to the private sector could raise medium-term sovereign debt sustainability concerns in the bloc’s vulnerable countries. Given low interest rates and a recent trend for issuing ultra-long-term debt that locks in low rates, the risks from higher sovereign debt in the near term were low said the bank.
Property prices are another key vulnerability. This is particularly in the case of commercial real estate, a market characterized by high demand and excessive valuations in the pre-pandemic years. Due to the pandemic, the work habits are changed and so the commercial real estate prices are already facing a substantial market correction. And also further price drops are likely, leading to possible lending losses or a collateral squeeze.
The ECB said that rising overvaluation in recent years has left room for a substantial price correction. This is as a majority of investors indicate that valuations have not bottomed out yet. Activity remained at levels around half of the long-run average, potentially masking a further decline in property prices. The ECB also added that this is a potentially sizable problem since lending for commercial real estate accounts for 7% of bank’s exposure to the private sector.
The residential property markets are in a better shape. But overvaluation is already evident, because it is partly a factor of ultra-cheap credit. The bank stated that the risk of a correction in residential property markets has increased amid signs of overvaluation for the euro area as a whole. It also added that in the coming year this downside risk in residential house prices points to a slowdown in price growth. But in the coming year an outright decline in prices is not expected.
