European Central Bank warns of bubbles in property and financial markets

• In its biannual stability report on Wednesday,the euro zone's central bank mentioned vulnerabilities in property and financial markets.
• On property, it said risks of price corrections over the medium term have increased substantially amid rising estimates of house price overvaluations.

The European Central Bank warned of stretched valuations in many asset markets, as the region continues to recover from the coronavirus pandemic on the back of ultra-low interest rates and massive stimulus measures.

In its biannual stability report on Wednesday, the euro zone's central bank mentioned vulnerabilities in property and financial markets, adding that "risk-taking by non-banks and elevated sovereign and corporate debt are building up."

On property, it said risks of price corrections over the medium term have increased substantially amid rising estimates of house price overvaluations.

"In particular, households with variable rate mortgages or shorter fixed-rate periods on their mortgages are exposed to an unexpected rise in interest rates, which could adversely affect their ability to service their debt," the report said.

Luis de Guindos, the vice president of the ECB, also highlighted a "striking buoyancy" for equity and risky asset markets, "making them more susceptible to corrections."

"There have been examples of established market players exploring more novel and more exotic investments. In parallel, euro area housing markets have expanded rapidly, with little indication that lending standards are tightening in response," he said in the report.

ECB buying slows

The central bank announced in September it would be buying fewer bonds off the back of surging consumer prices. This began the process of slowly winding down its huge pandemic-era stimulus package.

Inflation in the euro zone hit 3.4% in September, representing a 13-year high. Inflation then hit another 13-year high in October, at 4.1%, as the currency bloc battled surging energy costs.

In September, ECB President Christine Lagarde made it clear that the central bank's actions were a recalibration, but not a tapering. This is because the ECB is of the view that higher inflation is temporary and will fade throughout 2022.

Some market participants believe the ECB is underestimating inflationary pressures and will therefore likely have to announce a rate hike before the start of 2023. Indeed, money markets have priced in the probability of a 20-basis point hike for December 2022.

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