The Bank for International Settlements, which is the central banks’ central bank, has argued that the UK may have to consider raising interest rates more quickly than planned to prevent another financial crisis. Even in the face of economic fragility.

In its 81st annual report issued yesterday, BIS said that central banks should consider increasing interest rates faster than in the past when tightening their policy in response to the increasing inflationary pressures.

The report does though have some good news. It says that ‘ … the global economy has been moving towards healthy, stable, self-sustaining growth, albeit in fits and starts’. But then goes on to say that there is still a lot of work to be done in repairing the damage this economic crisis has caused.

It points to the global current account imbalances as well as the ‘immense gross financial flows coursing through the system’, with graphs at page 43 of their report that emphasise the point. And with that it says comes currency, liquidity and credit risks.

BIS also says that the huge increase in the size and complexity of countries’ central bank balance sheets are also a cause for concern. It singles out the UK and US as primary culprits, the Bank of England for example had expended its balance sheet from 8% of GDP to 20%. Any failure to manage their ‘still distorted’ balance sheets properly ‘ … could weaken their hard-won credibility in delivering low inflation, as could a late move to tighten policy through conventional channels’.

Systemically important financial institutions must also be made more resilient, says the report, so that even the failure of the largest of them would not collapse the system. On top of that organisations should be classified as banks if they act like banks, not classified on their legal formation.

The crisis also showed how little the regulators knew about the institutions they were supposed to be monitoring says the report. That is they had too little data to let them measure financial vulnerability and risk in the first place.

On the UK Monetary Policy Committee’s failure to adjust interest rates from the historically low 0.5%, BIS says ‘As yet, there has been no move by the Monetary Policy Committee, but one wonders how long its current policy can be sustained’.

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