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FRANKFURT: The eurozone financial stability outlook remains fragile as tighter financing conditions, high inflation and geopolitical tensions weigh on the single currency area, the European Central Bank warned Wednesday.

The ECB has hiked interest rates at a record pace to cool surging inflation over the past year, but consumer price rises are still above the bank’s two-percent target.

Higher borrowing costs, meanwhile, are taking their toll on the 20 nations that use the euro, with the European Commission last week lowering its growth forecasts for this year and next.

“The weak economic outlook along with the consequences of high inflation are straining the ability of people, firms and governments to service their debt,” said ECB vice-president Luis de Guindos, in the central bank’s latest Financial Stability Review. “It is critical that we remain vigilant as the economy transitions to an environment of higher interest rates coupled with growing uncertainties and geopolitical tensions.”

ECB set to pause rate hikes as eurozone feels pinch

The review warned that a recession was a “possible scenario” due to the deteriorating outlook.

The full impact of higher borrowing costs on economic activity was yet to be felt, and many sectors could face challenges as debt servicing costs rise, it said.

It pointed to real estate markets, which it said were already experiencing a downturn.

Banks – which had so far benefited from higher rates – could face problems as higher borrowing costs lead to falling loan demand, the review warned.

Concerns about euro area stability had been heightened by the outbreak of the Israel-Hamas war, it said. As well as the potential impact on energy markets, there was also the “potential to spark risk aversion in financial markets and undermine confidence in the real economy,” it said.

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