Chart of the Week : ECB Systemic Risk Indicator

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The ECB Systemic Risk Indicator was initially developed by Hollo, Kremer and Lo Duca in 2012, in the midst of the eurozone sovereign debt crisis. This indicator is based on fifteen financial stress measures (such as exchange rates, spreads etc.) and is used to track emerging market stress that could potentially impact the eurozone monetary policy. For the first time since the outbreak, it now stands at 0.15 – the highest level reached in 2018 and 2019 on the back of global trade tensions. This is still comparatively low. It skyrocketed to 0.34 in mid-March 2020 and 0.44 in 2012. But expect it to keep increasing in the short term both reflecting a repricing of risk in a world without QE and higher risk aversion due to the Russo-Ukrainian crisis. The repricing of risk will be more painful for some eurozone countries than for others. The Italy-Germany government bond spread is further moving upward at 167 basis points. The risk-zone is identified around 200-250 basis points by the market. Contagion to other Southern European countries is limited, for the moment. There is no eurozone fragmentation yet. As we are entering into a new monetary and economic paradigm (structurally high inflation and tightened monetary policy), investors need to get used to higher premium. We are at a crossroads. In our view, financial stress remains under control in the eurozone. This is more debatable in the United States. But if the ECB Systemic Risk Indicator gets back to the 0.20-0.25 area – which we identify as the danger area for the eurozone, this could force the ECB to adopt a more dovish stance. This could lead to a downward adjustment of ECB interest rate hike expectations too.