Days of low rates may be numbered as BIS warns against dangerous side-effects

By SAM FLEMING FOR MAILONLINE
Updated:

Ultra-low interest rates are causing dangerous side-effects that could endanger the economic recovery, a powerful global body warned yesterday.

The Bank for International Settlements said policymakers need to consider ratcheting up rates from near-zero levels, withdrawing from money printing operations and reversing hefty public spending programmes to avoid a renewed financial bust.

'The time has come to ask when and how these powerful measures can be phased out,' the BIS said in its annual report. 'We cannot ignore the fact that the cumulating side-effects themselves pose a danger that, at the very least, implies exiting sooner than may be comfortable for many.'

King

Uncomfortable: Mervyn King may find the BIS report unpleasant reading

The BIS report will make unpleasant reading for policymakers such as the Bank of England's Mervyn King, Ben Bernanke of the US Federal Reserve and European Central Bank President Jean-Claude Trichet.

During the global crisis they slashed official rates to historic lows to prop up teetering banking systems and imploding economies. Now with governments including the UK contemplating draconian deficit-cutting measures, they are under pressure to keep borrowing costs low.

But the BIS, which is based in Basel, Switzerland and sits at the heart of the central banking system, said some very difficult choices need to be made. Super low interest rates can reduce the incentive to cut back debt in countries such as Britain, while stoking up inflationary dangers.

What's more, major central banks have doubled the size of their balance sheets as part of efforts such as the BoE's £200bn quantitative easing scheme, which can 'distort' the prices of financial assets, it said.

Separately Monetary Policy Committee member Andrew Sentance reiterated his calls for higher UK interest rates, saying it would be better to increase borrowing costs slowly.

He said: 'I think it is desirable over this recovery to have a more gradual approach to tightening policy. Now that would imply moving in small steps and gradually, because I think there is a risk if you start tightening sharply you risk knocking back private sector confidence, which is the last thing I would want to do.'

The BIS also said budget deficits urgently need to be brought under control. It warned that Britain could see its gross public debt comfortably exceed 450pc of gross domestic product by 2040, compared with around 80pc now, if it doesn't take action.

Making matters worse, a continued deterioration of public finances could fire up inflationary pressures, adding to the need for higher interest rates, because the bigger the debt mountain becomes, the more tempting it would be to inflate it away.

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