FRANKFURT, March 26 (Reuters) – Euro zone banks have limited direct exposure to the war in the Middle East, but the conflict ‌could still generate systemic stress given interconnected vulnerabilities, European Central ‌Bank Vice President Luis de Guindos said on Thursday.

Financial markets have come under stress ​in recent weeks from the impact of the U.S. and Israeli war on Iran, but the selloff outside the Middle East has been limited, even as some assets remain overvalued.

“Spillovers to the euro area financial sector have ‌so far remained contained,” ⁠de Guindos said in a speech. “Direct bank exposures to the region are limited, and the banking system is well ⁠positioned with strong profitability and robust capital and liquidity buffers.”

De Guindos argued that even market infrastructure operators, like central counterparties whose services include energy markets, ​have managed ​margin requirements effectively, despite the volatility.

Still, ​there was a broader risk, ‌given interconnections in the financial system, said de Guindos, whose roles at the ECB include monitoring financial stability.

“Amid already elevated global uncertainty, this conflict could trigger the unravelling of interconnected vulnerabilities and cause systemic stress,” he said.

The conflict threatens to derail market sentiment at a time when ‌asset valuations are high, potentially leading to ​a sharp repricing of risk for leveraged ​borrowers and sovereigns while amplifying ​stress in the non-bank financial sector, he said.

On the ‌ECB’s core mandate of ensuring low ​inflation, de Guindos ​repeated the bank’s warning that inflation could rise and growth slow on the conflict but argued more time was needed to understand ​the full impact.

“We are ‌unwavering in our commitment to ensuring that inflation stabilises at ​our 2% target in the medium term,” he said.

(Reporting by ​Balazs Koranyi; Editing by Toby Chopra)

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UK inflation held at 3% in the year to February, before the start of the conflict in the Middle East, which has sent energy costs soaring and led to concerns of a resurgence in pricing pressures.

The latest consumer price index (CPI) reading from the Office for National Statistics (ONS), released on Wednesday, was in line with consensus expectations. This came after inflation fell to 3% in January from 3.4% in December.

The ONS said that clothing made the largest upward contribution to the monthly change in inflation in February, while motor fuels was the biggest downward contributor.

Read more: Multiple Bank of England interest rate rises expected after energy price surge

The data covered the period before the start of the conflict between the US, Israel and Iran on 28 February. The conflict has disrupted oil (BZ=F, CL=F) and gas (NG=F) supply, sending prices soaring, with concerns that a prolonged energy price shock could push inflation back up.

Grant Fitzner, chief economist at the ONS, said: “The largest upwards driver was the price of clothing, which rose this month but fell a year ago.”

“This was offset by falls in petrol costs, with prices collected before the start of the conflict in the Middle East and subsequent rise in crude oil prices.”

The Bank of England (BoE) warned last week that inflation will be higher in the “near term” due to the shock from higher energy prices, as it announced it had kept interest rates on hold at 3.75%.

Commenting on February’s inflation figures, chancellor Rachel Reeves said: “In an uncertain world we have the right economic plan, taking a responsive and responsible approach to supporting working people in the national interest.”

“We’re taking £150 off energy bills and providing targeted support for those facing higher heating oil costs. We’re also acting to protect people from unfair price rises if they occur, bring down food prices at the till, and cut red tape to boost long-term energy security — building a stronger, more secure economy.”

Ruth Gregory, deputy chief UK economist at Capital Economics, said: “The economy entered the energy price shock caused by the conflict in the Middle East with CPI inflation stuck at 3.0%.”

“And based on our current working assumptions about oil and gas prices, we now think CPI inflation could rise to a peak of about 4.6% in Q4.”

“With the energy price shock likely to extinguish growth and add to the already elevated unemployment rate, in our baseline scenario we still think an extended interest rate pause is more likely than interest rate hikes,” she said.