Global interest rates are too low and pose a rapidly growing risk to financial stability and economic growth, the Bank for International Settlements said on Sunday.
In its strongest warning yet that policy normalization should come sooner rather than later, the central bankers' central bank said economic growth across the world is uneven, debt burdens in many areas are high and rising, and the explosion of credit growth shows financial imbalances are building up again.
The Switzerland-based BIS said a major contributory factor has been the pursuit of "excessively low" interest rates in response to the 2007-08 global financial crisis and thedeflation scare triggered by last year's plunge in global oil prices.
But keeping rates anchored at these historic, ultra-low levels threatens to inflict "serious damage" on the financial system and exacerbate market volatility, as well as limiting policymakers' response to the next recession when it comes.
"Risk-taking in financial markets has gone on for too long. And the illusion that markets will remain liquid under stress has been too pervasive," the BIS said in its 85th annual report.
"The likelihood of turbulence will increase further if current extraordinary conditions are spun out. The more one stretches an elastic band, the more violently it snaps back."
Claudio Borio, head of the BIS's Monetary and Economic Department, summed up the state of the global economy and financial system as one of "too much debt, too little growth and too low interest rates."
'Instability and chronic weakness'
The first U.S. interest rate hike in almost a decade is now on the horizon and when the Federal Reserve does move, it will mark a turn in the global monetary policy tide. No fewer than 29 central banks have eased policy to some degree this year to boost growth, ward off the threat of deflation, or both.
The most notable of these has been the European Central Bank's 1.1 trillion-euro "quantitative easing" program of bond buying, launched in March and due to run through to September next year.
In strong language for the usually reserved BIS, it said extraordinarily loose monetary policy on a global level can cause "pervasive mispricing" in asset markets and that stocks and some corporate bond markets are now "quite stretched."
"In some jurisdictions, monetary policy is already testing its outer limits, to the point of stretching the boundaries of the unthinkable," the BIS said.
A return to more normal policies will be "bumpy", not least because low rates have given rise to a "faulty debt-fueled global growth model" - precisely what caused the crisis in the first place.
Central banks have carried the burden of ensuring the post-crisis recovery for too long, BIS said. Now longer-term policies to secure the stability of the global economy and financial system must be put in place, it said.
The leeway to do this opened up by the 60 percent plunge in oil prices between June last year and January this year is an opportunity governments should not pass up, the BIS said.
"Nothing is inevitable about this," it added. A failure on the part of governments, central banks and financial regulators to adopt more "prudent" policies would risk "entrenching instability and chronic weakness".