BIS warns of dangers of cheap money driving up stock prices

June 2, 2013 8:24 pm

BIS warns of dangers of cheap money driving up stock prices

By Claire Jones, Economics Reporter

Markets are “under the spell” of the world’s central bankers, with cheap money driving stock prices to record highs despite a lack of good economic news, the Bank for International Settlements has said.

The BIS, the so-called central bankers’ bank, on Sunday became the latest high-profile financial institution to warn that low rates and a plentiful supply of cash from quantitative easing had prompted investors to drive asset prices to record highs in spite of signs that a meaningful recovery continues to elude the global economy.

In the latest edition of its influential quarterly review, the BIS said further easing by some of the world’s big central banks in recent months had “helped market participants tune out signs of a global growth slowdown”.The Basel-based institution said the Bank of Japan’s “ambitious” pledge in April to double the monetary base of yen bank notes and reserves in circulation by the end of 2014 had “dominated” financial market movements. This “new phase” of monetary easing –which has also seen the European Central Bank cut rates to a fresh low of 0.5 per cent – coupled with some evidence of a US recovery in early May “boosted market sentiment and lifted the main equity indices to new highs”.

The strong performance of European bourses, which held up despite negative economic news and officials’ dithering over the banking crisis in Cyprus, highlighted the degree to which the world’s monetary authorities were driving investor behaviour.

Several senior central bankers have voiced misgivings about the optimism seen in financial markets since the turn of the year.

Though one of the intentions of quantitative easing was to buoy asset prices, both Federal Reserve chairman Ben Bernanke and Bank of England governor Sir Mervyn King have publicly warned in recent months that their policies risk inflating bubbles in asset prices.

At the same time, tightening credit conditions too early could plunge the global economy back into recession, highlighting the dilemma faced by central bankers, who are tasked with spearheading the recovery while at the same time avoiding a repeat of the crisis.

Holders of US Treasuries endured their worst month in two years in May, as uncertainty over when the Fed will taper off its bond purchases pushed prices lower. Stephen Cecchetti, head of the monetary and economic department at the BIS, said on Friday the recent movements in Treasury yields “should not come as a surprise”.

“Yields should go up as the economy recovers,” Mr Cecchetti said.

Bar the 7 per cent drop in leading Japanese equities witnessed in late May, volatility in financial markets had remained “subdued” over the past quarter, the BIS said. However, Mr Cecchetti said the “ride to normality”, as interest rates returned to their historical averages, would “almost surely be bumpy, with yields going through calm and volatile periods as market participants digest sometimes conflicting news about the recovery”.

A particularly acute risk was that higher interest rates would leave households, businesses and governments unable to service their debts.

“With the outstanding volume of government bonds greater than ever, interest rate risk – expressed as potential losses in relation to GDP – is at a record high in most advanced economies,” Mr Cecchetti said. “And these losses will be spread across banks, households and industrial firms.”