ECB warns high valuations boost financial-stability risks

[BRUSSELS] The European Central Bank sees “elevated” risks to the region’s financial stability, with stretched asset valuations prone to sharp adjustments and fiscal challenges in some countries that could test investor confidence.

“Market sentiment could shift abruptly on account of deteriorating growth prospects, for example, or disappointing news on artificial intelligence adoption,” the ECB said in its bi-annual Financial Stability Review, published on Wednesday (Nov 26).

It also cautioned that concern about high public debt in some advanced economies could strain global bond markets, which could shift international capital flows and jolt currencies.

The report echoes recent warnings from central bankers and regulators around the world about growing financial-stability risks. They, too, list record-high valuations in financial markets, rising public debt and lingering trade uncertainty.

In particular, the bull run in AI-related firms has captured the attention of officials who worry about a rapid correction. More recently, investors have started to question the scale of investments in the technology. That’s helped put the S&P 500 on track for its first monthly decline since April. 

The ECB stressed in its report that “persistently high valuations and increasing equity market concentration” raise the possibility of sudden price adjustments.

“Liquidity mismatches in open-ended investment funds, pockets of high leverage among hedge funds and opacity in private markets could amplify market stress,” it said.

On a potential repricing of sovereign risk, the ECB said it “would be more difficult to absorb today than previously due to a gradual shift in the investor base towards more price-sensitive investors.”

More recently, perceptions of risk have “focused on the deteriorating trajectory of fiscal fundamentals in France,” the ECB said. The region’s No 2 economy is struggling to rein in its budget deficit and debt load.

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At the same time, the ECB highlighted that – despite some trade agreements – doubts about the future and the longer-term economic and financial effects of tariffs continue to shape the euro-area financial stability landscape.

“Measures of trade policy-uncertainty have eased notably from their April highs,” Vice President Luis de Guindos said. “But uncertainty continues to linger, with potential for renewed spikes.” BLOOMBERG