ECB flags risk of market sell-off as investors shrug off war fears

Paris [France], May 28: European Central Bank Vice President Luis de Guindos warned Wednesday that the risk of a market correction has increased as investors continue pushing stocks to record highs despite ongoing geopolitical tensions, rising fiscal pressures and concerns surrounding private credit.
Speaking during an interview De Guindos said markets appeared to be underestimating several major risks tied to the war involving Iran, elevated asset valuations, and vulnerabilities in non-bank financial institutions. European and global equities have continued rallying in recent weeks even as instability in the Middle East and concerns over inflation remain in focus.
"There is a risk of a correction because valuations in markets are quite high," De Guindos said during a passage of the interview, adding that geopolitical developments remain the ECB's "main element of concern." He also flagged Europe's fiscal situation and the growing interconnectedness between banks and private credit institutions as areas of risk.
De Guindos said markets were currently pricing in a quick end to the war but warned that expectations could change if that fails to materialize.
"Markets discount that the conflict will be over shortly and if that's not the situation, that could trigger a modification in the perception of markets," he said.
The ECB also published its latest Financial Stability Review on Wednesday, warning that "geoeconomic stress" and energy supply disruptions were shaping risks facing the euro area economy.
The central bank said prolonged geopolitical tensions and fiscal challenges could weaken market sentiment if investors continue underestimating downside risks. Concerns remain particularly acute for highly indebted euro-area countries that could face pressure from higher borrowing costs and weaker investor confidence. The ECB warned that fiscal expansion in an uncertain geopolitical environment could result in a repricing of sovereign risk across parts of Europe.
The central bank additionally highlighted vulnerabilities tied to non-bank financial firms, including private equity and private credit institutions. The ECB said low liquidity buffers, concentrated exposures, and elevated valuations in those sectors could amplify stress during broader market downturns.
Recent scrutiny of private markets has increased globally as regulators examine leverage and liquidity risks outside the traditional banking system.
Financial Times reported that European regulators were stepping up monitoring of private credit funds amid concerns that stress in the sector could spill into wider financial markets during periods of volatility.
The warning from ECB officials also comes as investors reassess the path of interest rates in Europe.
The ECB has kept its key interest rate at 2% even after euro-area inflation accelerated to 3% in April. Policymakers have signaled that future decisions will remain dependent on incoming inflation and economic data.
ECB President Christine Lagarde has repeatedly stated that the central bank remains prepared to act if inflation pressures persist. According to Bloomberg, officials across the euro area have continued emphasizing the need to balance inflation risks against slowing economic growth as uncertainty surrounding global trade and geopolitical tensions intensifies.
De Guindos said the current environment has created a difficult balancing act for central banks trying to contain inflation while supporting economic activity.
"I think there is not any sort of fait accompli with respect to the evolution of rates," he said . "The discussion will be open and all the elements will be balanced and taken into consideration." Separately, Bank of France Governor Francois Villeroy de Galhau reiterated this week that the ECB remains committed to returning inflation to its 2% target over the medium term. Speaking to CNBC on Tuesday, Villeroy said markets should remain confident that policymakers would take necessary steps to stabilize prices.
The ECB's next inflation reading is scheduled for June 2, while the central bank's next policy meeting will take place June 10-11.
Source: Qatar Tribune