By David Barwick – FRANKFURT (EconoStream) – The risks to medium-term financial stability have clearly grown and relate chiefly to bank profitability and public debt in the context of weak growth, European Central Bank Vice President Luis de Guindos said Wednesday.

In remarks made by video at the Institute of International and European Affairs in Dublin, de Guindos called wider sovereign bond spreads worrisome for monetary policy, according to a text provided by the ECB.

‘Policy measures have so far helped prevent a health crisis turning into a systemic financial crisis, but medium-term risks to financial stability have increased markedly’, he said.

De Guindos noted in this connection that the economic recovery will remain shrouded in uncertainty for some time, but is subject to ‘substantial downside risks’, prominent among them being a further wave of the pandemic or a prolonged dampening effect of containment measures.

Fears of public or private debt becoming unsustainable could be fanned by economic deterioration, he cautioned, observing that corporates had been highly leveraged even before the pandemic. As for sovereign debt, while circumstances warranted a strong fiscal response to the crisis, countries with less room to maneuver could eventually face sustainability concerns, he said.

In the banking sector, the economic fallout from the pandemic poses ‘important challenges’, he said, observing the significantly lowered expectations of bank profitability this year. In view of further challenges to banks of a structural nature, de Guindos suggested that mergers and acquisitions could be a useful way of reducing sectoral overcapacity.

Although ECB action had provided monetary accommodation that has helped stabilise markets, it ‘has only slightly eased the tightening in financial conditions caused by the decline in stock prices and the increase in euro area sovereign and corporate bond yields’, he said.

‘The widening of sovereign bond spreads – on account of the macroeconomic outlook and the sizeable fiscal policy responses endorsed by national governments – is particularly troubling from a monetary policy perspective’, he continued. It is ‘crucial’ that risk-free rates be transmitted to all countries’ sovereign bond yields, he said.

The tightening financial conditions and the downward revision to medium-term inflation projections motivated last week’s policy decisions by the ECB, he said. The €600 billion expansion of the pandemic emergency purchase programme (PEPP) decided by the Governing Council ‘will bring us significantly closer to the pre-COVID-19 inflation path over the medium term’, he affirmed.

Authorities would ‘keep re-evaluating’ the potential need to readjust the PEPP as the situation evolves, he said. ‘We stand ready to adjust all of our instruments, as appropriate, to ensure that inflation moves towards our aim in a sustained manner.’

On economic developments, de Guindos reiterated that there were signs of a bottoming-out in the second quarter and that growth in the euro area would rebound in the second half, citing consumer and business confidence indicators.