Eurozone Deflation is Fitch’s Top Concern

Credit ratings agency (CRA) Fitch says that its Risk Radar has identified eurozone deflation as the largest potential risk to its credit ratings portfolio, despite the European Central Bank’s (ECB) quantitative easing (QE) programme.

This is because around one-third of Fitch’s corporate finance ratings are based in the region and as the world’s second-largest economy, largest importer and largest source of cross- border bank lending, deflation and weakness in the eurozone will have knock-on effects on other regions.

In its newly-published report, Fitch discusses these and other risks including emerging market slowdown and persistent oil price pressure.

Underlying inflation remains subdued and longer-term inflation expectations are still below the ECB’s target, adds Fitch. QE should help reduce the risk of prolonged deflation in the eurozone through a weaker euro and a boost to confidence. But the ECB’s previous easing measures, the introduction of targeted longer-term financing operations and private asset purchases, have so far had a limited impact on credit conditions and dynamics.

Downgrades would only occur if the bloc were heading into a protracted ‘Japan-style’ deflation, which could lead to self-reinforcing negative debt dynamics, making the downward spiral difficult to reverse – although this is not Fitch’s base case.

Emerging markets (EMs) face increasing pressures, primarily due to the structural adjustment in China and recession in Russia and Brazil. EM growth, which peaked at 6.9% in 2010, will slow to 3.6% in 2015, before edging up to 4.2% in 2016, according to Fitch’s forecasts.

Lower prices of oil and other commodities and tighter US monetary policy may affect EM external finances. The strong US dollar and higher US interest rates could also expose other EM vulnerabilities, such as high leverage, weak policy frameworks and political fragilities, so the risks for emerging markets are increasing.

The sharp fall in the price of crude oil since last summer is spurring spending and growth in developed economies by shifting wealth to energy consumers. At the same time, persistently low crude oil prices expose oil-dependent issuers across multiple sectors to heightened risks resulting from declines in revenue and cash flow. The largest financial impact is being felt across a disparate group of energy-producing sovereigns, corporates and public finance issuers whose forecast revenue streams have been cut substantially as oil prices have fallen to around US$50 per barrel.

The Risk Radar report frames the potential impact macroeconomic risks could have on Fitch’s ratings portfolio and their relative urgency. In today’s interconnected markets, similar issues may have an impact on multiple asset classes.

5 views

Related reading

US securities and exchange
Africa business i
flag
brexit-stars