MNI INTERVIEW: Low Rates Fuel "Ebullient" Markets

--Very Low Interest Rates, High Debt Levels Can Increase Market Vulnerabilities

By David Thomas

     BRUSSELS(MNI) - Very low interest rates and the search for yield are

stretching financial market valuations and potentially building up

vulnerabilities which could hurt longer-term economic growth prospects, Claudio

Borio, head of the Monetary and Economic Department at the Bank for

International Settlements told MNI.

     "Easy financial conditions tend to be good for economic activity in the

short run but can generate vulnerabilities that are counterproductive in the

longer run," Borio said in an interview ahead of the release of the BIS's Annual

Report.

     "One reason behind this ebullient state of markets is that interest rates

are very, very low and encourage a search for yield and a shift into equities."

     "If you look at equities and try and assess their intrinsic valuation by

looking at earnings, average dividends etc ... then they tend to look rich. But

if you compare them with bond yields then it's not so obvious. This highlights

the role that very, very low interest rates have in the valuations that we see."

     Very low rates have not helped the banking sector either, Borio said.

     "They provide a short-term, temporary boost to bank profitability, directly

and indirectly but, if they remain where they are, the temporary effect wears

off and they drive down the net interest margin."

     While the rise in public, private and corporate debt around the world does

not threaten any new Great Financial Crisis - it will mean "headwinds for

growth".

     --FINANCIAL CYCLE

     "If you include China, financial cycles have turned in a number of

economies that together account for roughly one third of global GDP and

financial cycles turning mean that this is going to be a headwind for growth."

     Borio says the world economy needs to end its dependence on monetary policy

- which can only ever be a "backstop for growth" - and seek a policy mix for

sustainable growth that also includes fiscal and macroprudential policies and,

most importantly, structural reforms.

     Reform efforts have been "flagging" since 2011 and should be renewed.

     "Such a different policy mix would put the global economy on a more

sustainable basis and it would move us away from this debt-fuelled growth model

that we have had for far too long."

     Borio also warned on trade tensions:

     "The risks are protectionism and political-type risks ... Protectionism can

damage the economy on a longer-term basis and not just for a couple of quarters,

because what it is doing is putting in doubt the very open multilateral global

trading system and raising big questions about the structure of global value

chains, which are a key source of productivity growth."

     Asked about the danger of a new currency war flaring up, with two of the

world's biggest monetary blocs seemingly embarked on a fresh round of policy

easing, Borio said tensions can become more likely when balance sheets are large

and interest rates very low. Exchange rates become a relatively more important

channel to influence the economy than when rates are coming down from a higher

level.

     "Because everyone is in the same boat, this naturally increases the risk of

potential tension," he said, adding: "This is so even though central banks are

just following their mandate." [i.e. by keeping rates low when inflation is low]

     "What is essential in this context is to avoid these kind of responses

becoming part of a political punching bag."

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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