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Policies create ‘illusion of liquidity’
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LOOSE monetary policies have created an “illusion of permanent liquidity” that is spurring investors to make risky bets and push up asset prices, the Bank for International Settlements said yesterday.
“The longer the music plays and the louder it gets, the more deafening is the silence that follows,” said Claudio Borio, who heads the BIS’s monetary and economic unit.
“Markets will not be liquid when that liquidity is needed most,” he warned, urging “sound prudential policies (and) extra prudence on the part of market participants themselves.”
Many central banks have kept their rates at record lows and pumped their economies full of liquidity first to stave off recession during the financial crisis and then to boost recent anaemic economic growth.
This month, the European Central Bank cut its key interest rates to new all-time lows and promised to launch a program of asset purchases to inject cash into the eurozone’s stalling economy.
The BIS, the so-called central bank of central banks, has warned such moves are fueling investors’ appetite for short-term, high-risk investments and froth in property markets, potentially creating bubbles for a new market crash.
Borio said markets have shown “exceptionally subdued volatility” at levels similar to before the financial crisis in recent months, which could be “a sign of high risk-taking.”
Unease over the conflicts in Ukraine and the Middle East caused a spike in volatility in early August, but that has since died down and “the search for yield has resumed in force,” he said.
Borio stressed that “a common mistake is to take unusually low volatility and risk spreads as a sign of low risk when, in fact, they are a sign of high risk-taking.”
“The illusion of permanent liquidity is just a prevalent now as in the past,” Borio said, pointing out that years of “unusually accommodative” monetary policy has left investors feeling secure low interest rates would continue or only be gradually tightened.
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