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Rivalry between ECB and inflation exposes financial system fragility
The ECB's confrontation with persistently high inflation reflects an increasingly hard-to-ignore vulnerability in the financial system. Rising interest rates are testing the resilience of households, businesses, the government and the housing market, the central bank said on Wednesday in its twice-yearly financial stability review. This leaves markets vulnerable to a disorderly adjustment, the central bank warned. While the banking sector has shown surprising resilience to the recent turmoil in the U.S. and Switzerland, rising funding costs and declining asset quality could still dent bank profitability. "Price stability remains critical to sustaining financial stability," ECB Vice-President Guindos wrote in the report's foreword, before setting out the side effects that policymakers must now accept. "The tightening of financing conditions to forcefully address high inflation has prompted a reassessment of the economic outlook and reversed overcompressed asset price risk premiums," he said. "As financial conditions normalize, this could expose vulnerabilities and fault lines in the financial system."