BIS warns of ‘disciplining force’ of financial markets
Italian bond ructions show governments have little space to fill void left by stimulus
The “disciplining force” of financial markets will leave debt-laden governments with limited room to boost growth as central banks ditch their crisis-era stimulus, the head of the Bank for International Settlements has warned.
Agustín Carstens, general manager of the central bankers’ bank, told the Financial Times: “Some markets are overstretched and so investors will be very jittery. There is less space for taking adventurous steps. Markets will be more volatile and more sensitive to adjustments in interest rates.”
Mr Carstens also said investors had become “a disciplining force”, citing the recent rise in Italian government borrowing costs after a now-rejected plan by Rome’s new coalition government for the European Central Bank to write off all their holdings of Italian debt — a move which the general manager said “sent all the wrong signals”.
Italian borrowing costs have since fallen back to 2.68 per cent after signals from new finance minister Giovanni Tria that Rome remains committed to membership of the euro.
Mr Carstens’ remarks highlight the difficulty facing economic policymakers who need to ensure growth remains on track, while taking onboard markets’ concerns about high debt levels in a world where central bank borrowing is no longer so cheap and plentiful.
Central banks across advanced economies are continuing to remove the support that they have provided following the worst crisis since the Great Depression, despite mounting threats to the global economic outlook. But there is little space for governments to fill the void even if those threats, such as a prolonged period of trade tension — and its possible escalation — materialise without triggering market turmoil.
With investors having to prepare for higher rates, governments would be unable to offset a slowdown in growth through boosting their spending due to high levels of debt. The BIS said in its closely watched annual report, published on Sunday, that public debt had risen to new peacetime highs and that small, open emerging markets where businesses had borrowed heavily in US dollars were particularly exposed to higher borrowing costs in the US. There had been an “excessive reliance” on easy monetary policy to boost growth, the BIS said.
“Emerging markets don’t really have space for poor fundamentals,” Mr Carstens said. “There is a risk of volatility in emerging markets, especially among companies with high amounts of debt.”
The Federal Reserve last week raised its benchmark federal funds range by another 25 basis points to between 1.75 per cent and 2 per cent. Rates are expected to rise by another 50bp before the end of this year, followed by an additional 100bp over the course of 2019, according to projections by US monetary policymakers.
Mr Carstens said the Fed needed to continue raising rates despite the risk of turmoil. “If the US leaves it too long, then there is a risk that inflation will return and that this will warrant a series of steep rate hikes over a short period of time,” Mr Carstens said. “The more moderate approach the Fed is taking to hiking rates will still come with volatility, but there is more hope that this volatility can be contained than if the hikes were steeper and quicker.”
The BIS, the Basel-based bank where several of the world’s central banks hold accounts, said in its report that after a “vintage” year in 2017, officials faced a difficult time in keeping the expansion on track.
The global economic outlook was under threat from various risks, among them a global trade war. Tensions over trade have escalated in recent weeks as the US administration has fallen out with most of the rest of the G7.
Mr Carstens signalled that the US was taking the wrong course by going it alone in imposing tariffs on other countries.
“Tariffs should only be adjusted in an orderly and collegial fashion. We have global, regional and bilateral processes and that is the way to do it,” Mr Carstens said, citing the World Trade Organization.
Mr Carstens, who before taking the job in Basel was the head of the Bank of Mexico, said the uncertainty caused by the US’s stance on trade had led to a dip in investment in the US’s southern and northern neighbours.
“Doubt has been cast on the rules of the game, and so we have seen investment dip in Mexico and Canada. That might now happen in the rest of the G7 and China. Most of the trade that takes place is through value chains, built on the assumption the rules would remain the same,” he said. “It is difficult to know exactly what would happen to the economy if the rules changed.”