Global financial conditions have improved significantly since the previous Financial Stability Review, despite the new uncertainty created by the proposed sovereign bailout for Cyprus in the past few weeks. Some earlier European policy initiatives had been seen as demonstrating a strong commitment to deal with the region’s sovereign debt and banking sector problems while maintaining the monetary union, and this boosted confidence over much of the past six months. Confidence was also enhanced by further signs of recovery in some of the major economies, notably the United States, supported by continued monetary stimulus. The improvement in global financial market sentiment has contributed to a rally in risk assets across a range of markets, consistent with increased risk appetite.
The improvement in market confidence has helped ease sovereign financing pressures for a number of euro area countries that had been subject to the greatest concerns about debt sustainability. Given the links between sovereign and bank balance sheets, this had positive spillovers to bank funding markets in the region. The euro area nonetheless still faces significant challenges to its stability. Many banks, particularly in the periphery, are still experiencing elevated funding costs, deteriorating asset performance and weak profitability amid subdued economic and property market conditions. This has contributed to tight credit conditions in the region as banks continue to deleverage and reduce their balance sheet risks.