ECB warns global markets could face sudden drop

By: DAVID McHUGH, AP Business Writer

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FRANKFURT, Germany (AP) - The European Central Bank says broad-based economic growth is keeping banks and markets stable in the 19-country eurozone - but warned that increased risk-taking by global investors could mean trouble down the road.

The ECB made its comments Wednesday in its twice-yearly financial stability review. The review aims to keep the public and government officials aware of potential problems that could disrupt the wider economy.

The report said the eurozone's increasingly robust economy "is supporting financial stability" and that there is no widespread overvaluation in eurozone's financial markets.

But markets remain vulnerable to sudden turns if investors get bad news that changes their risk outlook. The report noted that recent increased risk-taking in financial markets could "sow the seeds for large asset price corrections in the future."

The ECB noted that investors continued to favor riskier investments such as bonds issued by less creditworthy borrowers, a move boosted by expectations that central bank stimulus policies will continue. The ECB noted that such behavior has continued even though central banks such as the ECB and the U.S. Federal Reserve have made clear they are recalibrating their policies. "Financial markets may not be fully alert to the possibility that the current favorable market sentiment can change quickly," the report said.

Global stock markets in particular have continued an upward march in recent months. The STOXX Europe 600, a broad index of large, mid- and small-cap companies across 17 countries, is up 7.8 percent this year. Germany's DAX blue chip index has hit an all-time high in recent months, while the U.S. Dow Jones and Standard & Poor's indexes reached record highs Tuesday.

The health of banks and credit markets is important because that is where businesses get the financing they need to operate and expand. The stability review is therefore focused on risks that could hit the wider economy, not just investors.

Other risks to the financial system cited by the ECB included low profitability among banks due to high costs and overcapacity; large numbers of bad loans that are not being repaid clogging banks' balance sheets in some countries and impeding their ability to lend; and risks that bond funds aren't keeping enough cash buffers to meet redemptions in a sudden market plunge. The strong economy, however, makes it less likely that such risks will materialize and would limit the fallout if they do, the report said.

The ECB expects economic growth of 2.2 percent this year.

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