ECB warns Europe more vulnerable to emerging markets

European financial markets are increasingly vulnerable to turmoil in large emerging economies, the European Central Bank warned in a report Wednesday.

It said the eurozone financial system had proved “resilient” through brief periods of volatility in recent months, linked to Greece and China.

However, the ECB stressed that the “occasional bouts of financial market volatility suggest that vulnerabilities stemming from emerging markets are increasing”.

Of particular concern was the outlook for China, given its growing role in the world economy, the ECB said in its Financial Stability Report, published twice a year.

“Turmoil in Chinese and other emerging market economies’ equity markets in August led to a strong and broad spillover around the world, including to the euro area,” it said.

“This strong global co-movement of equity prices does not appear to have been solely driven by macroeconomic fundamentals,” it said, suggesting markets tend to overreact to developments in China.

“Developments in China and other large emerging market economies have become important drivers of global confidence,” the Frankfurt-based bank warned.

It said a “rapidly growing” eurozone investment fund industry had been gradually broadening its exposure to emerging markets, also including Brazil and Russia.

The report said that with interest rates at near zero and as the eurozone goes through “a weak economic recovery”, many investors are tempted by more high-risk, high-return investments in emerging markets.

“Partly as a result of increased vulnerabilities stemming from emerging markets, the risk of an abrupt reversal of global risk premia is increasing,” said the ECB paper.

Source: AFP