Prolonged Financial Market Volatility Could Dampen EU Economic Outlook
Over the past few days, the failure of SVB Financial Group and Signature Bank in the US and concerns over Credit Suisse's ability to restore stakeholders' confidence have led to heightened volatility in European financial markets, with banks' stocks particularly hit. Concerns over liquidity pressures or potential contagion could keep instability elevated for some time. In our view, if financial market volatility is prolonged, this is likely to weigh on the economic outlook for Europe and pose some policy challenges.We expect the impact from financial market instability on the European Union (EU) economy to be contained, although risks to the outlook have increased. Market concerns should ease reflecting both European banks' fundamentals and a timely response from European authorities. European banks in aggregate appear well capitalized, funded and with a stable deposit base. Liquidity requirements are strict. Nevertheless, confidence in the banking system could weaken and liquidity risks could increase if large deposit outflows materialise and authorities fail to act promptly, exacerbating contagion fears and prolonging volatility in the markets. In such a scenario, we see the European economic performance affected through two main channels: (1) weaker consumer and investor confidence, dampening consumption and investment; and (2) lower credit to the economy as banks reduce lending in response to a rise in their cost of funding.
“The latest ECB decision to hike policy rates by 50 bps in March 2023 could be followed by a more moderate pace of tightening or even a pause, as it weighs up potential risks to financial stability,” said Carlo Capuano, Senior Vice President, Global Sovereign Ratings at DBRS Morningstar. “The ECB could have to strike a balance between price stability and financial stability objectives carefully to avoid any inadvertent harm to the European economy,” said Adriana Alvarado, Senior Vice President, Global Sovereign Ratings.
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