Record Inflation Spells Trouble for Banks and States

The European Central Bank warned of rising stability risks for everyone from lenders to governments and households as the economic outlook darkens and officials battle record inflation.

The cost-of-living squeeze is hurting people’s ability to service debts, while Europe’s worsening growth prospects threaten corporate profits, the ECB said Wednesday in its Financial Stability Review, Bloomberg reported.

It also flagged potential dangers to public finances as governments borrow to cushion the impact of the energy crisis, further downward pressure on equities and said house prices may be peaking after a yearslong advance.

“People and firms are already feeling the impact of rising inflation and the slowdown in economic activity,” ECB Vice President Luis de Guindos said in a statement. “Our assessment is that risks to financial stability have increased, while a technical recession in the euro area has become more likely.”

The mix of soaring prices and shrinking output created by Russia’s war in Ukraine is challenging policy makers as well as investors. The ECB has embarked on its most aggressive cycle of interest-rate increases ever to keep inflation from becoming entrenched -- even as an economic downturn looms.

The hikes are set to continue, with steps to reduce the central bank’s €5 trillion ($5.2 trillion) bond portfolio also taking shape.

Risky assets remain “sensitive to the uncertain path of inflation” as well as monetary policy and economic developments, the ECB said. Some, including US equities, “still appear stretched given fundamentals” -- even after large corrections, it said.