ECB warns of financial turmoil.

A toxic mix of recession, soaring inflation, rising funding costs and lower liquidity threatens to trigger financial market turmoil in the eurozone, the European Central Bank has warned. Luis de Guindos, the vice-president, urged banks to take more provisions for bad loans, global regulators to make investment funds hold more liquid assets, and the ECB to be prudent in starting to shrink its €5tn bond stockpile next year. The ECB’s twice-yearly financial stability review said high inflation, a growing likelihood of a recession and rising financing costs «pose increasing challenges» for indebted households, businesses and governments and could produce more bankruptcies and financial market volatility. However, this should be done «with a lot of prudence», de Guindos said.

The ECB said that this year’s turmoil in UK gilt markets and an earlier cash crunch that hit European energy traders had underlined how the region’s financial system was increasingly vulnerable to sharp moves in market prices. It called on global regulators, coordinated by the Financial Stability Board, to accelerate work to address the non-bank financial sector’s vulnerability to liquidity squeezes, similar to one that hit money market funds after the pandemic struck in March 2020. De Guindos said the priority was for investment funds exposed to the risk of rapid and large-scale withdrawals in times of stress to be forced to hold a certain proportion of liquid assets. «The risk remains high that investment funds could, in an adverse scenario, amplify a market correction via procyclical selling behaviour».

«It cannot be the same ‘whatever it takes fiscal policy approach that we have seen during the pandemic,» de Guindos added.

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