FRANKFURT Financial stability risks in the euro zone are contained but remain significant and have even increased in some areas over the past six months, the European Central Bank said in a regular stability review on Wednesday.
Concerns over debt sustainability have risen, while the clean up of the banking sector is slow and the risk of a sudden repricing in bond markets remains significant, potentially leading to major capital losses, the ECB said.
The warning comes as the euro zone is enjoying its best economic run in a decade, raising expectations that the ECB could soon start to unwind its massive stimulus measures.
"Risks to euro area sovereign debt sustainability have increased over the past six months," the ECB said. "In recent weeks, however, euro area spreads narrowed and sovereign stress conditions improved somewhat following the result of the presidential election in France."
The ECB added that risks stemming from a further rapid repricing in global fixed income markets are mostly related to spillovers from the United States but a prolonged period of elevated political uncertainty or higher-than-expected euro area inflationary pressures could also act as triggers.
"Repricing risks in fixed income markets remain significant," the ECB said. "There are... risks that euro area bond yields could increase abruptly without a simultaneous improvement in growth prospects."
The ECB singled out an upward revision of expectations for U.S. interest rate hikes as a key risk and warned that a repricing of euro zone bond markets could lead to substantial capital losses for investors.
Resolving bad loans on banks' balance sheets is a top concern but progress has been slow so far, the ECB said.
Meanwhile bank profitability is low and market valuations suggest no relief in sight even though market pressures have abated recently.
The ECB said Brexit -- Britain's forthcoming exit from the European Union -- is not one of its main stability concerns for the time being.
(Reporting by Balazs Koranyi; Editing by Catherine Evans)