BIS Says Europe’s Debt Crisis Stoking Global Financial Turmoil

The Bank for International Settlements said investors are becoming increasingly concerned about the consequences of Europe’s sovereign debt crisis and weaker growth in Asia and the U.S.

“By late May, optimism had given way to doubts about European economic growth, the financial health of euro-area sovereigns and banks, the impact of fiscal consolidation on growth, and political stability inside the euro area,” the Basel, Switzerland-based institution said in its quarterly report published today. “Together with signs of greater fragility in U.S. and Chinese growth, all this unsettled investors and stoked global financial-market volatility.”

Confidence among investors, entrepreneurs and consumers had increased at the beginning of the year after the European Central Bank flooded financial markets with more than 1 trillion euros ($1.2 trillion) in cheap three-year loans to unlock credit. While the market for unsecured bank bonds reopened temporarily at the beginning of the year, many banks from the euro-area periphery continued to rely on covered bonds and government-guaranteed bonds for funding, the BIS said.

Optimism started to fade in the second half of March. The Stoxx Europe 600 Index (SXXP) has since dropped about 14 percent, reversing first-quarter gains, and yields on Spanish and Italian debt have surged.

Changed Mood

“The mood shifted as it became increasingly clear that monetary-policy actions alone would not be sufficient to resolve underlying euro-area economic problems,” the BIS said. “A trickle of weaker-than-expected economic data cast further doubts on the strength of the global growth recovery.”

China led a slowdown in manufacturing across Asia in May, the number of Americans applying for unemployment benefits rose, and euro-area business confidence tumbled to the lowest in 2 1/2 years. The International Monetary Fund on April 17 forecast global economic growth will slow to 3.5 percent this year from 3.9 percent in 2011.

The BIS said banks recorded the largest decline in aggregate cross-border claims in the fourth quarter since the collapse of Lehman Brothers Holdings Inc. in 2008. The decline was “largely driven by banks headquartered in the euro area facing pressures to reduce their leverage,” the BIS said.

The BIS also said that while the expansion of central-bank balance sheets in emerging Asia over the past decade coincided with stable inflation and stable financial systems, they “have now reached a size that distorts markets and increases the risks of inflation and financial instability.”

To contact the reporter on this story: Jana Randow in Frankfurt at jrandow@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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