Financial markets should be wary of stubborn inflation and a sharper economic slowdown next year than forecasters predict, the Swiss-based adviser to central banks has warned.
The Bank of International Settlements said exuberant stock markets were at risk of ignoring the negative aftershocks from persistent inflation, which could trigger a wave of insolvencies and a steep fall in property prices.
Claudio Borio, the organisation’s chief economist, said it was clear that there was a squeeze on credit growth, indicating that banks were putting up the cost of borrowing and restricting access to credit, forcing firms closer to bankruptcy.
Property prices were also falling, he said, calling into question how the financial system will absorb the losses.
Stock markets have soared this year in the US and some parts of Europe, despite rising interest rates. The S&P 500 index rose by 16% from 3,824 on 3 January to 4,450 on Friday when the market closed. The German Dax has jumped by 12% from 14,069 on 2 January to 15,805 on Monday morning.
Central banks are expected to begin reversing their recent increases in the second half of 2024 once it becomes clear economies are slowing and unemployment rising.
However, cuts to interest rates next year could be delayed if inflation fails to fall as quickly as expected, said Borio.
“Inflation could once again surprise on the upside,” he said, forcing central banks to keep rates higher for longer than expected by international investors.
“Central banks are aware of the possible risks. It is about whether financial markets are properly taking into account these risks.
“There are two related risks. One is that inflation might turn out to be more stubborn than it’s already priced in markets. And the second is the background. And the background is that financial cycles have been turning. By that I mean that credit growth has been slowing in general and that asset prices, particularly I would say property prices, have started falling,” he said.
“What we have seen so far in terms of market disruption, or market stress, has been associated primarily with the interest rate risk, but the question is going to be how resilient the overall financial system is going to be in order to absorb those losses. And particularly how large and persistent those losses are going to be.”
Oil prices have spiked since June, sending a barrel of Brent crude up by almost 30% from $72 to $94 on Monday.
A large number of companies also expect to boost profit margins over the next year, keeping prices higher for longer and delaying the fall in inflation.
Inflation in the UK was 6.8% in July and is expected to increase to 7.1% in August in response to rising oil prices when the latest figures are published by the Office for National Statistics on Wednesday.
US inflation, which has fallen more steeply than in the UK or continental Europe, is also under pressure from the rising cost of fuel.