IMF system strong but challenges ahead

LONDON – World financial markets have strengthened but cyclical challenges are emerging from the prospect of higher interest rates and an unwinding of global imbalances, the International Monetary Fund said yesterday.

In its latest Global Financial Stability Report the IMF said its 2005 assessment of the global financial system gathering resilience had been validated but new challenges required “a more nuanced view of the financial outlook for the remainder of 2006 and beyond”. Major cyclical risks that lay ahead for financial markets stemmed from higher interest rates and/or higher inflation, worsening credit quality of various debtors and a sudden unwinding of global imbalances.But coming from a position of strength, financial systems should be able to cope with such risk “rather well”.”The most likely cyclical setting for financial markets in 2006 could be defined as ‘not bad, but not as good as the stellar year 2005’,” said the report, presented in London.Over recent years, the IMF said, low interest rates and abundant liquidity had supported a solid global economic recovery.Banks and firms had cut costs, allowing corporate earnings to rebound strongly and balance sheets to improve.Household balance sheets had also strengthened in the last few years thanks to rising house prices and a stock market recovery and this scenario of healthier banks, firms and households created financial cushions against shocks.But the favourable conditions supporting that would not persist, the Fund warned.”At a time when policy interest rates have been raised and credit quality is expected to deteriorate somewhat, a number of questions arise,” the report said.It cited uncertainties over how fast cyclical conditions would alter, the impact on asset reallocations and price corrections and how well financial systems were cushioned against changes.Examining the chances of an unwinding of global imbalances, the IMF said the expected narrowing of favourable growth and interest rate differentials for the United States was likely to mean a slower pace of foreign accumulation of US assets.This would weaken the dollar and push US bond yields up somewhat.A disorderly unwinding could be sparked by events such as military confrontation, a major terror attack, a big fall in oil or other energy supply or a significant rise in protectionism.But such uncertainties were near impossible to quantify.- Nampa-ReutersMajor cyclical risks that lay ahead for financial markets stemmed from higher interest rates and/or higher inflation, worsening credit quality of various debtors and a sudden unwinding of global imbalances.But coming from a position of strength, financial systems should be able to cope with such risk “rather well”.”The most likely cyclical setting for financial markets in 2006 could be defined as ‘not bad, but not as good as the stellar year 2005’,” said the report, presented in London.Over recent years, the IMF said, low interest rates and abundant liquidity had supported a solid global economic recovery.Banks and firms had cut costs, allowing corporate earnings to rebound strongly and balance sheets to improve.Household balance sheets had also strengthened in the last few years thanks to rising house prices and a stock market recovery and this scenario of healthier banks, firms and households created financial cushions against shocks.But the favourable conditions supporting that would not persist, the Fund warned.”At a time when policy interest rates have been raised and credit quality is expected to deteriorate somewhat, a number of questions arise,” the report said.It cited uncertainties over how fast cyclical conditions would alter, the impact on asset reallocations and price corrections and how well financial systems were cushioned against changes.Examining the chances of an unwinding of global imbalances, the IMF said the expected narrowing of favourable growth and interest rate differentials for the United States was likely to mean a slower pace of foreign accumulation of US assets.This would weaken the dollar and push US bond yields up somewhat.A disorderly unwinding could be sparked by events such as military confrontation, a major terror attack, a big fall in oil or other energy supply or a significant rise in protectionism.But such uncertainties were near impossible to quantify.- Nampa-Reuters