London — The Bank for International Settlements (BIS) urged the world’s top central banks on Sunday to keep lifting interest rates but warned escalating trade tension between the US and China could turn into a dangerous downward spiral.
The new head of the BIS, former Mexican central bank chief Agustin Carstens, spoke to Reuters as the central bank umbrella group delivered its first annual report under his watch.
It comes after a volatile five months for the global economy in which 2017’s financial market rally shuddered to a stop and US President Donald Trump caused widespread dismay by imposing hundreds of billions of dollars worth of trade tariffs.
"We are entering into a dangerous dynamic where these type of protectionist issues start having side effects on currency markets and financial flows," Carstens said. "We can start a very dangerous spiral that at some point can really affect the growth of the world economy and financial stability."
For now, though, the baseline BIS scenario is that as long as there is no galloping escalation in trade tension or borrowing costs, the global economy will continue to improve.
It therefore backed the Federal Reserve to keep moving up US interest rates and for other major central banks like the ECB to ease out of massive stimulus programmes that have been in place for years.
"I think it is important for the normalisation to proceed gradually," Carstens said. The pace of Fed hikes had been "adequate".
"Unconventional policies have been useful for bringing us to where we are right now … but it has come at a cost and the cost is that some vulnerabilities have been building up in the financial markets."
Stock market rises had resulted in overstretched valuations in places, bond market spreads had become very compressed and house prices in some of the small open economies that dodged the financial crisis a decade ago were now very high. "If central banks wait longer before normalising, it is very likely that these imbalances will continue growing and the risk of having financial instability in the future is higher."
Moving up interest rates and ending years of unprecedented stimulus in major economies is likely to cause some turbulence in financial markets, which companies, borrowers and investors should prepare for.
"Volatility is to be expected in the process of normalisation," Carstens said. "The key is for this not to spin out of control."
The report said the global economy remained bright though it was "somewhat unusual" to keep seeing such strong growth after so many years of expansion, and to see only modest inflation.
Carstens highlighted the hammering many emerging markets have taken, including Argentina, Turkey, Brazil, SA, India, China and Mexico.
"What has made life more difficult for emerging markets is that some items that were not foreseeable years ago are playing a role right now, and one of them is protectionist issues."