July 9, 2018 / 3:07 PM / in 4 months

EU watchdog says rate hike could threaten debt sustainability

FRANKFURT (Reuters) - The sustainability of private and public debt in the European Union may be under threat if interest rates rise, the bloc’s financial risk watchdog said on Monday.

The European Central Bank said last month it would likely stop its stimulus program at the end of this year and may raise rates in the autumn of 2019.

“A scenario where interest rates increase, for example due to increased risk premia... could put debt sustainability and, as a consequence, financial stability at risk,” the European Systemic Risk Board said in its annual report.

The ESRB, chaired by the ECB President Mario Draghi, upgraded its assessment of the severity of this risk to “medium”.

Investors have so far taken a benign view of the gradual policy tightening mapped out by the ECB, with the 10-year benchmark interest rate for the euro area - a gauge of borrowing costs based on German bond yields - at a paltry 0.30 percent on expectations of continued support from the central bank.

But they have been demanding a bigger premium to hold Italian debt over its German counterpart since an anti-establishment government took power in Rome with a promise cut taxes and spend more.

The ESRB said a reversal in financial markets remained the only “high risk” facing the EU, and it downgraded risks relating to weak balance sheets in the financial sector to “medium”.

The ESRB identifies three categories for financial vulnerabilities over up to three years: risk, medium risk and high risk.

Reporting By Francesco Canepa; editing by John Stonestreet

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