The turbulence seen this last spring, triggered by bank failures outside the euro area,  has now abated. While risks to financial stability may appear less acute, they remain  elevated. Attention has shifted towards the impact of tight financial and credit  conditions and weak economic prospects on the debt servicing capacity of  borrowers, the ongoing correction in real estate markets and the resulting risks for  banks and non-bank financial intermediaries.

While tight financing conditions help align aggregate demand with supply and ensure  that inflation returns to target, they can also push over-extended borrowers into financial distress. Steep increases in interest rates are particularly challenging for  borrowers carrying high levels of debt contracted at variable rates or loans that fall  due for refinancing in the near term. Disposable incomes, corporate revenues and  fiscal positions may suffer an additional squeeze if economic activity disappoints  further or if energy prices surge over the coming winter. 

Despite such risks, financial markets have remained resilient. This strength reflects  expectations of a soft landing, with limited impacts on economic growth as inflation  recedes to moderate levels. Sentiment could shift quickly if actual outturns were to  deviate from this benign scenario, and disorderly adjustments could be amplified by  non-bank financial institutions with elevated credit and liquidity risks. An escalation of  the conflict in the Middle East could trigger a sharp increase in risk aversion in  financial markets, unravelling the prevailing vulnerabilities. In addition to the potential  adverse repercussions for the supply of energy commodities, an escalation could  undermine general confidence and slow down economic growth, while pushing  inflation rates up in parallel.