The Bank for International Settlements (BIS) warns of further financial stress as central banks continue to raise rates to combat inflation. The report stated that the more central banks lift rates, the higher the risk of financial stress and bank failures. The last opportunity to fight inflation and restore price stability will be the most challenging for central banks.
The issue with inflation lies in the fact that the labor market remains tight and prices in the services sector continue to increase. Agustin Carstens, General Manager of BIS, said that if wage growth and prices reinforce each other, inflationary psychology will take hold, meaning that interest rates may have to remain high for a longer period than expected by the public and investors.
The rate hikes made by central banks amid high levels of debt will likely reveal additional vulnerabilities in the financial system. The best example of this could be the bank closures at the beginning of this year. If central banks have to tighten measures more aggressively or for a longer duration to achieve price stability, the risk of financial stress will increase.
The BIS calls for prudent policies by banks, including tightening budgetary expenses and implementing additional risk management measures, to stabilize the global economy and financial system. Carstens said the monetary policy should restore price stability, while fiscal policy needs consolidation.
The BIS also assessed that nearly 15% of rate-hiking cycles lead to serious stress in the banking sector.