#MacroFriday: Sovereign Debt Sustainability Worries ECB

The aim of the ECB’s biannual Financial Stability Review (FSR) is to raise awareness of systemic risks to financial stability in the Euro Area, with the ultimate goal of preserving financial stability. In its most recent report, the ECB expressed concerns about concentrated equity markets and the combination of weak economic growth prospects and fragile fiscal fundamentals. Fiscal slippage by governments poses a real threat to financial stability in the eurozone (again), particularly in an environment of slow growth and rising geopolitical uncertainties.

While the ECB’s market interventions played a crucial role in lowering interest rates over the past decade, it is now continuing its balance sheet reduction. By the end of this year, the ECB will completely stop reinvesting maturing bonds acquired under the PEPP. As the ECB steps back from its role as the ‘buyer of last resort,’ European countries refinancing maturing debt and issuing new bonds will need to rely on other investors to fill the gap.

For now, spreads have remained relatively contained. However, the FSR highlights the risks building for sovereigns with high deficits and elevated debt levels. The report shows that the most indebted countries in the eurozone are projected to see their annual interest payments rise above 3% of GDP over the next decade—reaching as high as 6% for Italy. Adding to the challenge, Belgium, France, Spain, and Italy will likely need to repay and refinance more than 15% of their total outstanding sovereign bonds, all against the backdrop of higher interest rates. Let us hope that the FSR receives the attention it deserves from national policymakers before financial markets increase the pressure—and a new euro crisis becomes unavoidable.