May 24, 2018 / 10:10 AM / a year ago

UPDATE 1-ECB's Praet sees political "clouds" over strong euro zone economy

(Combines Praet, Financial Stability Review)

By Francesco Canepa

BRUSSELS, May 24 (Reuters) - The euro zone’s economy is in good shape but there are “clouds” relating to government policy, for example in Italy, that could undermine confidence, the European Central Bank’s chief economist said on Thursday.

The ECB has fuelled a recovery in the euro zone’s economy since 2015 through massive injections of cheap money, but it is expected to dial back its stimulus measures and eventually raise interest rates in the coming year.

Praet reaffirmed his optimism about the economic outlook and said weaker-than-expected data recently was partly due to temporary factors and “supply constraints”, such as labour shortages in Germany.

But he also emphasised some “clouds” on the horizon, including plans by Italy’s would-be government to loosen fiscal policy and roll back a pension reform, and international trade tensions.

“Economic conditions remain good,” Praet told a financial industry event in Brussels. “There are some clouds and we should be watchful because that can go into confidence in a more fundamental way.”

A new, anti-establishment government is close to taking office in Italy on pledges to cut taxes and jack up spending.

In a report published earlier on Thursday, the ECB warned indebted euro zone governments that loosen the purse strings risk falling out of favour with investors, particularly if economic growth slows.

It listed Belgium, France, Italy and Portugal as being at risk of breaking European Union budget rules.

“A deteriorating growth environment or a loosening of the fiscal stance in high-debt countries could impact the fiscal outlook and, by extension, market sentiment towards some euro area sovereign issuers,” the ECB said in a statement accompanying its Financial Stability Review.

Italy’s 10-year bond yield hit a 14-month high earlier this week, pushed up by growing political risks, although it was falling on Thursday after comments by Italy’s Prime Minister-designate Giuseppe Conte.

Praet said fiscal space to stimulate demand in Italy was limited due to its high government debt but added that the ECB was still in “wait and see” mode as the new government’s programme was light on financial details.

Speaking later at the same event, the chief executive of Italy’s largest bank, UniCredit’s Jean Pierre Mustier, said he saw no reason to believe “political noise” would hurt confidence in Italy. He was more worried about an economic slowdown originating in the United States, he said. (Reporting By Francesco Canepa Editing by Catherine Evans)

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