Bank for International Settlements criticizes rate cuts in annual report

29 Jun 2015 | Author: | No comments yet »

BIS warns low interest rates could spell ‘entrenched instability’.

The BIS, which acts as a forum for global central banks, argues low rates aimed at stimulating growth in the short term may actually do the opposite over longer periods. The annual report from the Bank of International Settlements (BIS) found the collective of ANZ, Commonwealth Bank, NAB and Westpac secured pre-tax earnings as a percentage of assets at 1.28 per cent, only trailing banks in the emerging economies of China (1.83 per cent) and Brazil (1.66 per cent).The Bank for International Settlements has fired a new broadside against “exceptionally easy” monetary policies that it blames for worsening financial distortions, jacking up debt and making it tougher for the global economy to get back on a track of sustainable growth. “For some time now, policies have proved ineffective in preventing the build-up and collapse of hugely damaging financial imbalances, whether in advanced or in emerging market economies,” the BIS says in its annual report, released Sunday. “These have left long lasting scars in the economic tissue, as they have sapped productivity and misallocated real resources across sectors and over time.” Low rates do not merely reflect the current economic malaise, the BIS argues.Near-zero interest rates could become chronic in the world’s major economies unless ”a firm hand” is used to raise them back to more normal levels.

It said cheap money encourages more debt and creates financial booms and busts that leave lasting scars on the economy — with the result that central banks apply more cheap money to try to lift the economy. “Rather than just reflecting the current weakness, low rates may in part have contributed to it by fuelling costly financial booms and busts,” the BIS report said. BIS, an international organisation of central banks, also hinted at concerns with the latest rate moves from the Reserve Bank of Australia, suggesting it was risky to focus on commodity prices and exchange rate movements instead of inflation. “The central banks in Australia, Canada and Norway eased as inflation declined along with commodity prices, even though core inflation remained close to target,” BIS noted in its report. “Overall, short-term macroeconomic factors have been the dominant justification for policy decisions; financial developments have been far less prominent.” “Since the Great Financial Crisis, deleveraging has progressed in some economies, but in others, housing prices and debt remain very high and in many cases have grown further,” BIS said. Major central banks have kept low benchmark rates in place to stimulate the economy after the shock delivered by the global financial crisis of 2007-2009. The intervention is remarkable because the BIS, as the club for central banks from where global monetary and financial policy is co-ordinated, is hugely influential.

But it cautioned that global debt burdens and financial risks remained too high, while productivity and financial growth were too low, leaving policy makers with little room to maneuver. In short, low rates beget lower rates.” Rates “have been exceptionally low for an extraordinarily long time, against any benchmark,” Claudio Borio, head of the monetary and economic department, told reporters from the bank’s headquarters in Basel, Switzerland. “Moreover, the negative bond yields that have prevailed in some sovereign bond markets are simply unprecedented and have stretched the boundaries of the unthinkable. The recent market gyrations have not fundamentally altered the picture.” “Rather than promoting sustainable and balanced global growth, the system risks undermining it,” Mr. A number of countries, including Switzerland, Denmark and Sweden, have in recent months introduced negative rates, meaning investors have to pay to lend money to these states.

Between December 2014 and the end of May, around $2.0 trillion in global long-term sovereign debt, much of it issued by euro area sovereigns, was trading at negative yields, BIS said. The current low rates “are a vivid reminder of the extent to which monetary policy has been overburdened in an attempt to reinvigorate growth,” Borio said. “They have underpinned the contrast between high risk-taking in financial markets, where it can be harmful, and subdued risk-taking in the real economy, where additional investment is badly needed,” he said.

Extraordinarily low interest rates are not a “new equilibrium” said Jaime Caruana, general manager of the BIS, rejecting the theory of so-called “secular stagnation” which some economists blame for the continued decline in global lending rates. “True, there may be secular forces that put downward pressure on equilibrium interest rates … [but] we argue that the current configuration of very low rates is neither inevitable, nor does it represent a new equilibrium,” he said. The economies worst hit by the last crisis are now suffering the costs of persistent ultra-low rates, the organisation said, which could “inflict serious damage on the financial system”, sapping banks and weakening their balance sheets and their ability to lend. And the continued misallocation of resources during busts prompted by central banks’s rock-bottom interest rates has also hammered productivity growth, the BIS said, as a prolonged reliance on debt had been used in its place.

The latest salvo by the BIS, whose membership consists of 60 central banks and monetary authorities, comes a year after a harsh critique in which it urged policy-makers not to make the mistake of raising rates “too slowly and too late.” At the time, the BIS scolded Canada, Australia, Sweden and other “small advanced economies” for sticking to ultra-low rates too long. Mr Caruana said that during booms, workers and capital are shifted to slow-growing sectors, with a “long-lasting negative” impact on productivity growth. “Misallocated labour needs to move from these sectors to other parts of the economy,” he said. Federal Reserve has taken its foot off the gas pedal but has shown a reluctance to step on the brakes in the face of conflicting economic signals and persistently low inflation.

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