The European Central Bank has warned that the European countries’ inability to continue reducing their public debt makes them susceptible to negative impacts from geopolitical tensions and persistently high interest rates.
According to the central bank’s biannual financial stability review, many European governments have not fully reversed the support measures implemented during the COVID-19 pandemic and the energy price shock triggered by Russia’s invasion of Ukraine. This failure leaves them exposed to potential risks and vulnerabilities.
The ECB highlighted that market participants might reassess sovereign risk due to elevated debt levels and relaxed fiscal policies, leading to increased borrowing costs and adverse effects on financial stability. This could affect private borrowers and sovereign bondholders through spillover effects.
Although risks to the financial system have somewhat diminished in recent months, with household and corporate debt declining from pre-pandemic levels, sovereign debt is expected to remain high. The ECB specifically pointed out “lenient fiscal policies” as a key concern.
While there are expectations of economic recovery in the coming years, supported by resilient labor markets, lower inflation rates, and anticipated interest rate cuts by the ECB starting next month, the bank cautioned that “structural challenges” continue to hinder productivity and growth.
