BIS: Has sentiment swung too far?

Claudio Borio, one of the world’s most senior central banking officials, has urged central bankers around the world to exploit the current tailwinds and put economic growth on a sounder footing.

This policy challenge will demand resilience domestically and globally, he said at a Sunday briefing following the release of the Bank for International Settlement's annual report. BIS is dubbed the central bankers’ bank because global monetary authorities hold accounts there.

In a cautionary speech, Borio said resilience means strengthening the economy’s capacity to absorb shocks to adapt to long-term trends and avoid the build-up of financial imbalances. 

"Such imbalances were the root cause of the global financial crisis and the key source of risks ahead," warned the head of the BIS monetary and economic department.

"Domestically, this calls for rebuilding policy space in fiscal and monetary policies and for implementing with urgency structural reforms - the only strategy that can raise growth on a sustainable basis. Lightening the burden on monetary policy is essential.

“Globally, it calls for reinforcing the multilateral approach to policy in financial regulation crisis management trade taxation and even monetary policy. Fortunately, we live in a deeply interconnected world. The problems we face are global; the solutions must be global too. It would be illusory to think and act differently.”

Watershed in financial markets

The central banking official said the US presidential election had marked a watershed in financial markets. And, in its wake, markets became more buoyant and volatility drifted to very low levels - normally a clear sign of high risk appetite.

Borio argued that while the reflation trade has lost a lot of momentum since the beginning of the year, its imprint is still visible especially on equity markets.

“The hard data has improved but not as much as sentiment has,” he said. "We had already stressed last year that the rhetoric being used to describe the global economy was too downbeat. Thus, one good year has been sufficient for economic conditions to become the most favorable since the global financial crisis.

"Growth has strengthened considerably," he said during his speech, and is forecast to return to long-term averages soon. Economic slack in the major economies has diminished further; in some unemployment rates have fallen back to levels consistent with full employment. And inflation has moved closer to central bank objectives.

“Still one may legitimately ask whether sentiment has swung too far. The doubts about the future derive from tensions that will have to be resolved at some point and from long term developments that may eventually threaten growth," Borio added.

“There is tension between readings of financial market volatility, which have plummeted, and the indicators of policy uncertainty, which have surged. There is tension between stock markets, which have soared, and sovereign bond yields, which have not risen much as economic prospects have brightened."

Four risks

And, unfortunately, he went on to say, "the unwelcome long-term developments we term the risky trinity in last year’s report are still with us: unusually low productivity growth unusually high debt and unusually narrow room for policy manoeuvre".

Against this backdrop, Borio spoke about four medium term risks to the outlook: a possible flare up of inflation, financial stress linked to the contraction phase of financial cycles, weaker consumption not offset by stronger investment and a rise in protectionism.

If those deep forces have not yet run their course, he added, the end of the current expansion might be different.

"The end may come to resemble more closely a financial boom gone wrong, just as the latest recession showed with a vengeance. Leading indicators of financial stress point to financial booms that in a number of economies look qualitatively similar to those that preceded the global financial crisis.”


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