Trade war could hit financial stability, warns ECB

The European Central Bank warned on Wednesday that weaker-than-expected growth and a possible escalation of trade tensions could trigger further falls in asset prices.

In its latest Financial Stability Review, the bank said uncertainty about global economic growth prospects had contributed to bouts of high volatility in financial markets.

"If downside risks to the growth outlook were to materialise, risks to financial stability may arise," said Luis de Guindos, vice-president of the ECB. "The growth outlook is central to all the main risks to financial stability."

"Should downside risks to growth materialise, financing costs for vulnerable sovereigns are likely to increase which may unearth debt sustainability concerns," the ECB said. "In addition to the high level of debt and large fiscal deficits, some countries could face rollover risks if market participants were to reassess sovereign risk."

The ECB also said that bank profitability is expected to remain low in the eurozone. Its estimates point to an aggregate return on equity of around 6% over the next two to three years. A large share of eurozone banks will not be able to meet the expected returns required by investors, it added.

"That said, euro area banks’ capital adequacy remains strong, implying widespread resilience to plausible adverse scenarios. Notwithstanding this near-term resilience, the FSR highlights that any change in the credit rating outlook could lead to higher medium-term funding costs for banks.

"In order to return to sustainable profitability, euro area banks need to tackle a number of structural challenges - such as low cost-efficiency, limited revenue diversification and still high stocks of legacy assets in some countries."

The warning from the ECB came as trade tensions between the US and China escalated, after a Chinese official said products made from China's rare earth minerals should not be used against the country's development. The comment, reported by CCTV, was taken as a veiled threat aimed at the US, whose technology companies are dependent on the materials.