IMF warns of low interest rates 'risk' to economy

Investors could chase riskier assets if interest rates stay low, the IMF says

The International Monetary Fund has warned of new risks to global financial stability.

Low interest rates could lead investors to buy riskier assets as they seek better returns, the IMF says.

In a new report, it says there is a danger that this behaviour could derail the economic recovery, which the IMF has already described as "weak and uneven".

The report says the risks require "increased vigilance".

The IMF has already given its assessment of the wider economic recovery and is concerned about its lack of vigour.

This new report takes a closer look at the health of the financial system. Its problems gave us the global recession and it will have a central role in determining the strength and durability of the recovery.

Side-effects

The conclusions are unsettling. The root of the problem is the actions taken by central banks to stimulate the recovery.

The IMF report does not for a moment dispute that they are necessary. But, as medication often does, they have had side-effects.

The measures involved are very low interest rates, now in place in the US, Britain, Japan and the eurozone, for example.

There are other steps - such as quantitative easing or creating new money to buy financial assets - taken by some central banks.

The impact has been to drive down the return investors can get from lending money to borrowers with good credit ratings, or from buying their bonds - which are a way of borrowing using tradable financial assets.

So in what is often called a "search for yield", they have bought other types of assets - such as shares, and bonds issued by less creditworthy borrowers - driving up the prices of those assets.

Low interest rates have also made it more attractive to borrow money to make speculative investments.

Signs of excess

The IMF says that now prices "in virtually all the major asset classes are simultaneously stretched".

Volatility in financial markets is low and so is the premium that high-risk borrowers have to pay - the extra interest it costs them compared to a safer borrower.

The report says: "What is is unusual [about these developments] is that they have occurred simultaneously across broad asset classes and across countries in a way that is unprecedented."

In particular, it says: "Growing signs of financial excesses are emerging in the United States."

There is a risk of financial instability, the IMF says. Rising interest rates - expected in the US and Britain next year - would trigger falls in bond prices.

Geopolitical developments could also trigger a change in attitude to riskier investments.

There is some good news in this report. Banks are generally in better shape - they have more capital - than at the start of the crisis. And household debt has come down from its peaks in some countries, including the US, Britain and Spain.

But big picture for this report is one of a financial system that still needs a very wary eye on it.