LONDON -- In a bleak assessment, credit ratings agency Moody's warned Tuesday that Europe remains highly vulnerable to another economic downturn despite all its firefighting efforts over the past few years.
The Moody's report, published as Italian stocks and bonds were falling over the populist government's spending plans, said Europe "is not ready to cope with another major slump stressing the financial system."
It noted five vulnerabilities that could deepen the impact in Europe of the next downturn, including higher debt levels, peaking assets prices and regulatory risks.
"Overall, the amount of wiggle room available to mitigate the impact of another downturn is shrinking," said Paolo Leschiutta, senior vice president at Moody's.
The warning follows a relatively calm period for the 19-country eurozone, which has grappled with the global financial crisis and the subsequent debt crisis over the past decade.
The region enjoyed strong economic growth last year and unemployment has fallen to a decade-low rate of 8.1 percent. Greece, meanwhile, is no longer reliant on bailout loans.
As a result, the European Central Bank has started to rein in its crisis-era economic support measures. It is planning to halt its bond-buying stimulus program at the end of this year before possibly raising interest rates again next year.
However, the sense of calm has been shaken recently, largely from concern over Italy. The new government there has fleshed out tax and spending plans that will, if enacted, see the country's budget deficit swell. Investors have taken fright -- on Tuesday, the FTSE MIB stock index was down 1.3 percent, while the interest rate charged on the country's 10-year bonds rose a further 0.10 percentage point to 3.4 percent.
Without directly mentioning the plans of the Italian government, Moody's is warning that policies by governments and central banks over the past few years to heal the European economy will limit what they can do during the next economic decline.
It highlighted that high prices for some assets mean that there could be a sudden drop if interest rates rise quickly. And it said low growth and still high unemployment in some places continue to fuel economic insecurity and could foster further anti-establishment political movements.
Moody's wasn't alone in warning about the outlook for Europe. Berenberg Bank also said a "cocktail of risks" are constraining growth.
"After smooth sailing in 2017, the eurozone has faced a series of head winds since February 2018," said Holger Schmieding, chief economist at Berenberg.
"The risks to growth range from trade tensions and a still unresolved [EU exit] to trouble in vulnerable emerging markets, higher oil prices and dangerous reform reversals in Italy."
As Italian bond yields touched a four-year high, the euro extended losses and the region's equities slumped, while haven assets such as German bunds and the Swiss franc rallied. Goldman Sachs warned that the risk of a wider impact of the Italian turmoil has increased, even as markets in Spain and Portugal -- seen as a key barometer for any debt contagion to Europe's periphery -- have so far shown little sign of anxiety.
Italian budget official Claudio Borghi's comments that the common currency is "not sufficient" to solve the country's fiscal problems have rekindled worries that a breakup of the world's largest trade bloc is still a possibility. He later denied that the country's populist government had any plans to leave the euro. Two-year German debt, a popular hedge against regional risks, saw smaller gains this week than in May, suggesting that the latest Italian sell-off is driven more by concern about fiscal weakness than the risk of an exit from the euro.
"European risky assets remain vulnerable and there is potential for negative spillovers to the euro area given the high trade exposure to Italy," Goldman Sachs strategists led by Alessio Rizzi wrote in a research note. "While our economists do not expect systemic implications for the global economy, contagion risks have risen."
Information for this article was contributed by Pan Pylas of The Associated Press and by John Ainger of Bloomberg News.
Business on 10/03/2018