The European Stability Mechanism (ESM) has warned of a new escalation of tensions in the Middle East and a sudden revaluation of US assets in its first ever“Eurozone stability watch”, could cause“Permanent damage” to the European economy. ESM said that while the eurozone has shown“Amazing resilience” in dealing with the 2008 financial crisis, the 2020 Covid-19 pandemic and the 2022 conflict between Russia and Ukraine, but at a time of high debt and deficits and soaring defence spending, this resilience“Can not be taken for granted”.
ESM presented an“Adverse scenario” in which the situation in the Middle East escalated again, compounded by a sudden“Significant revaluation” of US equities and bonds, this would push the eurozone into“A recession from which it will never fully recover”. It calculates that the double shock would shrink annual eurozone GDP by 2 per cent by 2035, an amount equivalent to the size of Finland’s economy.
ESM was set up in 2012 at the height of the Eurozone crisis to provide emergency financial assistance to countries. The report comes amid warnings of growing global and eurozone financial risks. According to euromonitor, the most frequently cited risks include attacks by US President Donald Trump on the independence of the Federal Reserve, changes in US stock market valuations, high global debt levels and rising geopolitical tensions. More disturbingly, two or more of these risks could combine to create a systemic shock in the future.
According to Euronews, ESM’s chief economist said global instability puts“Very high demands” on governments. “Difficult policy choices are inevitable,” Strauch said bluntly. “More decisive fiscal adjustment is needed in many member states to maintain the credibility of EU fiscal rules.”. The rules limit deficits and debt to 3 per cent and 60 per cent of annual output respectively.
In recent days, a number of senior European officials have voiced concerns about the Eurozone’s economic outlook. European central bank executive board member Isabel Schnabel said at an event in Rome on the 6th that despite the drop in oil prices, the eurozone economy has not returned to its pre-conflict state in the Middle East, core inflation remains strong and price pressures persist.
ECB governing council member and Italian Central Bank Governor Leon Panetta warned on the 7th that, “The outlook remains fragile, with risks to inflation continuing to coexist with downside risks to growth,” he said, calling for monitoring of geopolitical dynamics, supply chains, wages and inflation expectations, and stressed the need for monetary policy to be tested against a variety of scenarios.