Bank of Japan policy change risks eurozone bond turmoil, warns ECB

Eurozone bond markets are at risk of a selloff caused by a sudden withdrawal from Japanese investors if the Bank of Japan ends its extremely loose monetary policy, the European Central Bank has warned.

“If the Bank of Japan decides to normalize its policy, it could influence the decisions of Japanese investors, who have a large presence in global financial markets, including those in the euro area,” the ECB said in its biennial Financial Stability Review. The bond market is also involved.” on Wednesday.

The ECB said the risk of a “sudden withdrawal of Japanese investors from the euro zone bond market” was one of myriad potential threats to the eurozone financial system, while it warned the bloc to remain stable even after recent banking turmoil in the US and Switzerland. Decided to be flexible enough. ,

The Frankfurt-based institution said a possible policy change in Japan would add stress to eurozone debt markets as it begins reducing its own bond holdings by the ECB this year.

Japan’s central bank has signaled in a recent first step in unwinding its extremely loose monetary policy that interest rates will remain at or below current levels after the country’s inflation rose to its fastest rate in four decades.

Japanese investors have huge exposure to eurozone government bonds, especially French debt, as well as US Treasuries and Australian bonds.

The ECB said normalization of Japanese monetary policy could lead to a “sharpening of the rate differential and increased exchange rate volatility”, which it said could “reduce the attractiveness” of carry trades – in which investors Borrow at low rates in Japan to invest. High-yielding bonds abroad.

High Japanese rates may prompt investors to repatriate funds, while “valuation losses on local bond portfolios and high risk-free rates may deter investors’ risk-taking behavior, including their desire to invest abroad.” “.

ECB Vice President Luis de Guindos said its own recent policy tightening – including a 3.75 percentage point increase in its deposit rate since last summer – “could reveal weaknesses in the financial system”.

He said it was “vital” to monitor such threats, which include falling commercial property prices, higher borrowing costs for governments and banks, rising bankruptcies and less liquidity in financial markets.

He added that these heightened risks, along with growing uncertainty over the economy, made it even more important to “fully implement a banking union” in the single currency block by introducing a common deposit guarantee scheme for political leaders.

Banks in the eurozone have proved “resilient” to the collapse of several US banks and the crisis at Credit Suisse, which forced it into the arms of rival UBS, the ECB said, citing “strong capital and liquidity” among the region’s lenders. Pointing to the position of .

But it warned that there were signs of deterioration in the credit quality of loans on banks’ balance sheets as high borrowing costs, weak growth and high inflation fueled bankruptcies. “Banks may therefore need to set aside more funds to cover losses and manage their credit risks,” it added.

Property markets in the eurozone are “going through a correction”, the ECB said. The recent fall in house prices has been “orderly so far”, but it warned it could become “disorderly” if demand continues to be hit by rising mortgage costs. It added that the slowdown in commercial property markets “could test the resilience of investment funds”.