Over the past few months, the European economy has been under the simultaneous effect of two unprecedented exogenous shocks of international scope. The invasion of Ukraine by the Russian Federation has, in some dimensions, amplified the economic impact of the pandemic. The effects on the energy and raw materials markets and on supply chains has conditioned the recovery of economic activity and aggravated inflationary pressures. Additionally, adding to the increased uncertainty, the balance of risks for inflation projections is biased upwards due to the possibility of a longer conflict and additional energy supply constraints.

In this context, at its meetings in June, the ECB continued the process of normalising monetary policy, announcing for July the end of APP net purchases, but maintaining the flexibility of PEPP reinvestment and the increase in key interest rates. In September, there will be a new increase, the calibration of which will depend on the medium-term inflation outlook. 

The main risks for financial stability are:

• An additional revaluation of risk premiums, notwithstanding the correction that has already taken place, which may interact with the vulnerabilities accumulated during the pandemic and reduce asset prices, with an impact on the financial system, particularly on portfolio valuation.
• A reduction in prices in the residential property market, arising from changes in financing conditions. 
• With regard to the financial situation of households, the reduction in real disposable income due to inflation and the effect of the increase in interest rates on debt servicing, to which the uncertainty regarding the evolution of economic activity and employment must be added;  
• The increased probability of corporate default, reflecting the joint effect of the financial vulnerability of some corporations, the incomplete recovery of activity and profitability of several sectors in the post-pandemic period and the current macroeconomic and financial environment.
• The general government debt-to-GDP ratio not continuing on the downward path foreseen, due to the uncertainty about economic activity and the increase in financing costs;  
• In the coming years, the increase in interest rates will translate into an improvement in banks' net interest income and into an increase in the recognition of impairments and potential losses arising from the devaluation of debt securities at fair value. The impact of each of these risk factors is conditioned by the evolution of economic activity and differentiated according to the time horizon.

Over a longer horizon, other challenges may affect the economy in a transversal and structural manner, with implications on economic growth and inflation. The materiality of these challenges, including the slowdown in international trade, the pressure on energy markets and the increased digitalisation of the economy, will require a significant investment effort from resident institutional sectors. The capacity of banks to generate capital, the room for manoeuvre of fiscal policy and the indebtedness and debt service of the non-financial private sector, constitute vulnerabilities that limit investment decisions. Therefore, an efficient use of the European funds from the Recovery and Resilience Plan (RRP) becomes even more important. 

Macroprudential  policy must take into account the challenges posed to financial stability, structural vulnerabilities and the origin of systemic risk. Of particular note in recent months has been the adjustment to the Recommendation on new consumer credit and mortgage loans, making the maximum maturity of new mortgage operations dependent on the age of borrowers.