The Iran war and lingering trade tensions could dent euro zone economic growth, push up borrowing costs and challenge some member states’ ability to sustain public budgets, a European Central Bank report concluded.
Financial markets have mostly shrugged off the war in Iran, leaving stocks at rich valuations, corporate borrowing costs low and the spread between sovereign bond yields across the 21-nation bloc at low levels, raising fears that investors may be complacent about risks.
“A scenario of notably weaker growth associated with a more persistent energy shock could trigger a reassessment of fiscal sustainability and an abrupt repricing in sovereign bond markets,” the ECB said in a biannual Financial Stability Report.
Such a repricing could then raise corporate borrowing costs, setting off a feedback loop that could endanger financial stability and hit the real economy.
This risk is especially acute because governments are already financing a long list of urgent projects, limiting their fiscal buffers and their room to manoeuvre.
“High sovereign financing needs related, among other things, to defence spending, the green transition and potential fiscal measures to cushion households and firms from rising energy prices, are likely to add to pressures over the medium term,” the ECB added.
