Daily Management Review

ECB Warns Real Economy Can Be Hit Quite Fast By A Full Blow Trade War


ECB Warns Real Economy Can Be Hit Quite Fast By A Full Blow Trade War
There can be “bouts of high volatility” in financial markets because of increasing uncertainty about global economic growth, warned the European Central Bank (ECB).
There can be further falls in asset prices could be triggered by a possible escalation of trade tensions and the weaker-than-expected growth, warned the RCB in its Financial Stability Review (FSR) that gives outcome of the central bank’s review of the potential risks to stability in the euro zone.
The escalating trade war between the U.S. and China has seen multiple periods of heavy selling in the global stock markets. Since the beginning of May, there has been a drop of more than 4.6 per cent and 4 per cent in the Dow Jones Industrial Average index and the S&P respectively.  
A full-blown trade war between the U.S. and China would be “extremely detrimental”, said Luis de Guindos, vice president of the ECB, during a television interview after the release of the report. Guindos added that “it could affect not only the volatility of markets, it could affect the real economy quite rapidly.”
Increasing trade tensions would be “very negative news” for the global economy, he said while talking about the current global economic slowdown.
Compared to a December 2018 forecast of 1.7 per cent for growth of the euro zone for the entire of 2019, the ECB reduced its growth forecast for the zone to 1.1 per cent in March this year. There had been a “sizable moderation in economic expansion that will extend into the current year,” ECB President Mario Draghi said at the time.
The findings from the new report were “not actually a bad situation,” said Luke Hickmore, a senior investment director at Aberdeen Standard Investments.  “The ECB are doing exactly what you’d hope they’d do — they’re warning you about risks, but you’re getting well paid for a lot of those risks if you’re in credit markets,” he said, adding that within the credit landscape “there are lots of attractive opportunities around European banks, with a few risks.”
Weaker corporate earnings could particularly impact the growing global leveraged loan sector, identified the report published on Wednesday. Leveraged loans are those forms of loans that are given to those companies or individuals who already carry a considerable amount of debt on them or they have a poor credit history. According to S&P, the market for leveraged loans in the US recently touched a value of $1 trillion.
Because of continued low profitability in the euro area, there would be pressure on the banks in the region, the ECB further warned. Expected returns of around 8 to 10 per cent required by investors would potentially be missed by a significant portion of European banks, suggested the estimations of the ECB.
Long-standing structural problems can be tackled by banks by consolidation, said De Guindos. “Consolidation could be an instrument, not only domestic consolidation but also cross-border consolidation, could be an instrument in order to get rid of this excess capacity and to start to gain efficiency in terms of costs and in terms of profitability, but this is something that has to be implemented by the management of the banks,” he said.