Hardening interest rates can hit global financial system


The International Monetary Fund in its Global Financial Stability Report said that World financial markets have strengthened but cyclical challenges are emerging from the prospect of higher interest rates and an unwinding of global imbalances.

In its latest Global Financial stability Report the IMF stated in its 2005 assessment of the world 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, according to the report.

The Fund’s top capital markets official cautioned a human flu pandemic which may be unlikely but if takes place posed a nastier risk that could spark a sharp and deep recession. He also urged countries to ensure they can cope with an avian flu outbreak and provide suitable funds to overcome the financial and health problems.

The IMF capital markets director Gred Haeusler presenting the stability report said that coming from a position of strength, financial systems should be able to cope up with any risks internationally.

The director told a news conference in London that from a financial stability perspective, the near term outlook is as good as it gets, or even better than that.

The report noted that in recent years, 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 process and a stock market recovery. This scenario of healthier banks, firms and households created financial cushions against shocks. But the IMF warned the favorable conditions supporting that would no longer persist. It cited uncertainties over how fast cyclical conditions would alter the impact on asset reallocations and price corrections. The report has also cautioned on the ability of how well financial systems were cushioned against the changes.

Examining the chances of an unwinding of global imbalances, the IMF said the expected narrowing of favorable growth and interest rate differentials for the US was likely to mean a slower pace of foreign accumulation of US assets.