Europe's macroeconomic outlook is brighter – but markets may be underestimating the possibility of sudden destabilization due to geopolitics, the European Central Bank's vice president said Thursday.
“We are talking about the election cycle that will take place not only in the United States, but also in Europe. At the same time, we point out the geopolitical risks. I think markets, you know, sometimes underestimate the potential impact,” Luis de Guindos told CNN’s Annette Weissbach. NBC: “The geopolitical risks are there.”
He said markets are good at calibrating financial and economic risks but struggle to integrate the separate dimension of geopolitical risks that are often viewed as an all-or-nothing binary.
Stock markets in Europe and the United States have risen to record highs this year, riding out the impact of ongoing wars in the Middle East and Ukraine and a host of upcoming elections in which half the world's adult population will head to the polls.
The European Central Bank on Thursday released its latest financial stability report, which stated that financial stability in the euro zone has improved due to improved economic outlook and lower inflation.
The ECB warned in the report that rising geopolitical risks pose “significant downside risks.” He added that risks remain “high” on a historical basis, given factors such as rising debt servicing costs, signs of bank profits peaking, and the ongoing decline in commercial real estate.
The report attributes the rise in financial markets to analysts' expectations of a reduction in interest rates from major central banks this year.
“Increasing signs of pricing for perfection create the potential for significant market reactions to disappointments,” the report said.
De Guindos said the ECB did not take into account any concrete outcomes when it came to the election results, but overall they raised the possibility of further fragmentation in the global economy.
The Vice President of the European Central Bank pointed to the increase in tariffs and the implementation of protectionist measures by some countries. “This will lead to fragmentation of trade and growth and will reduce the potential growth of the global economy,” he added. “This comes on top of the risk factors from Ukraine and the Middle East.”
De Guindos warned that a sudden correction in the market constitutes a “potential weak point.” “This is a risk we must take into account as we look to the future.”
“And that's the element that you can't ignore, you can't overlook that potential impact that can impact risk aversion, risk attraction, commodity prices, growth, overall growth in the global economy.”
