Euro zone stability risks contained but remain aplenty: ECB

FRANKFURT (Reuters) – Risks to euro zone financial stability remain contained, supported by an ever-broader economic expansion, even if the bloc continues to face a list of vulnerabilities, the European Central Bank said in a stability report on Wednesday.

With 18 straight quarters of economic growth, the euro zone has been on its best footing in a decade and leading indicators suggest the expansion is finally reaching periphery nations, potentially restarting their long-stalled convergence.

“Improved economic conditions underpin the assessment that there is no generalized overvaluation in euro area financial markets,” the ECB said. “Nevertheless, global risks in particular may trigger financial asset market corrections with negative repercussions on financial stability.”

Top vulnerabilities include an abrupt repricing of global risk premia, weak bank sector profitability, renewed public debt concerns and liquidity risks in the non-bank financial sector, the ECB said in a biannual report.

“Continued risk premia compression and signs of increased risk-taking behavior in financial markets are sources of concern as they may sow the seeds for large asset price corrections in the future,” the ECB said.

Addressing a regular concern in Germany, the ECB argued that residential property prices appear to be broadly in line with fundamentals for the bloc as a whole, even if prime commercial property prices have continued to rise above their long-term averages.

The Bundesbank, a long-time critic of the ECB’s lax policies, argued earlier on Wednesday that German property prices may be 15-30 percent overvalued, even if mortgage lending risks still appear to be limited.

While euro zone banking profitability has recovered somewhat, bank valuations remain poor, pointing to doubts about lenders’ ability to earn returns corresponding to the cost of equity.

This is a potential risk since resolving the sector’s high stock of non-performing loans raises the chance that more capital will be required for some, a costly exercise given low valuations.

While a rise in bond yields could also reignite sovereign debt concerns, most countries have increased the duration of their debt, suggesting that any rise in funding costs would have a more gradual impact, the ECB added.

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