ECB Sounds Alarm on Financial Stability as Policy Uncertainty Mounts

The European Central Bank has sounded an alarm over financial stability in the eurozone, warning that a sharp rise in uncertainty over government policies on everything from trade to defense has put the financial system at risk.

In its biannual Financial Stability Review, the ECB cautioned that investors may be overly complacent about threats stemming from recent tariff increases. “Buoyant credit and stock markets appear to be ‘out of sync’ with a world dominated by geopolitical and trade uncertainty,” the report stated.

“A significant increase in global uncertainty regarding trade, defense, international cooperation, and regulatory policies could prove challenging for financial stability,” the ECB said.

Officials believe investors may be underestimating the risk of the economy performing worse than expected, an escalation in trade tensions, or a failure to deliver anticipated monetary policy easing.

“Despite pullbacks, equity valuations remain stretched, while credit spreads still appear ‘out of sync’ with underlying credit risk,” said ECB Vice President Luis de Guindos.

The central bank described tariffs as a “major downside risk.” It estimated that a one-standard-deviation increase in an index measuring trade policy uncertainty would cut the median growth forecast by 0.15 percentage points after four quarters. Such a spike in uncertainty also led to a 10.4% drop in bank stock prices after six months and raised their borrowing costs in the bond market by 7 basis points, according to the ECB’s analysis.

Among other risks, the ECB also highlighted cyberattacks, concentrated investments in private markets, and the growing—though still weak—links between cryptocurrencies and traditional finance.