BIS warns of inflation, financial risks from Middle East conflict
BIS General Manager Pablo Hernández de Cos warned that escalating Middle East tensions could drive global inflation upwards and growth downwards. In an interview with The Nikkei, he highlighted financial stability risks and the need for central bank vigilance.
Navigating supply shocks and fiscal risks
Hernández de Cos noted that the global economy's scenario has shifted due to the Middle East conflict, disrupting energy supplies and threatening to fuel inflation while dampening growth.
He distinguished the current situation from the 1970s oil shocks by emphasizing central banks' strong credibility and robust monetary policy frameworks.
The textbook response to a temporary supply shock is to "look through" it, provided inflation expectations remain stable and second-round effects are avoided.
However, if the shock persists, this approach becomes less suitable, especially with heightened sensitivity to price dynamics post-pandemic.
Central banks must closely monitor inflation expectations, ready to tighten monetary policy if they drift upwards.
He also stressed the importance of fiscal policy, warning that broad and persistent stimulus could considerably increase inflationary risks and endanger fiscal sustainability, given record-high public debt levels in many countries.
Countries that are net energy importers face a negative terms-of-trade shock, resulting in real income loss, which authorities can only redistribute in the short run.
Fragilities in sovereign debt and private credit
The BIS General Manager highlighted profound repercussions of prolonged energy market disruptions on the global economy, posing severe risks to financial stability.
He reiterated BIS concerns about growing fragilities in sovereign debt markets, noting a marked increase in public debt globally over the last 15 years, increasingly intermediated by non-bank financial institutions (NBFIs), including highly leveraged hedge funds.
Despite recent buoyant market sentiment driven by AI optimism and hopes for a swift resolution to the Middle East conflict, Hernández de Cos warned of potential abrupt market corrections if these expectations prove wrong.
He also expressed concerns about the rapid growth and opacity of private credit, particularly in the US and Europe, emphasizing the need to monitor its linkages with the broader financial system, including insurance and banks.
The AI sector is under close scrutiny due to its ballooning external financing, often from private credit firms, and the high interconnectedness of its supply chain, which could lead to widespread reverberations from issues with a single key player.
Regulation, digital currency, and independence
The interview underscores the ongoing tension between regulatory effectiveness and market evolution.
While post-crisis banking reforms have strengthened resilience, they may have inadvertently shifted riskier activities to less regulated NBFIs, necessitating congruent regulation.
The discussion on stablecoins highlights their potential for efficiency but also their inherent risks to convertibility and financial integrity due to their operation on permissionless DLT networks.
The contrasting approaches to CBDCs between the eurozone and the US reveal a critical challenge for global payment system coherence, emphasizing the BIS's role in fostering multilateral cooperation.
Finally, Hernández de Cos's personal stance on central bank independence serves as a crucial reminder of its foundational role in maintaining price stability and macroeconomic resilience, provided it is coupled with accountability and transparency.