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IMF gives cautious read of 2015 prospects

Financial markets are under-pricing risk in easy-money environment, it says

Financial markets have been optimistic, marked by high equity prices, compressed spreads and low volatility, says the IMF.


THE International Monetary Fund (IMF) has issued a guarded assessment of global economic prospects for the coming year, and warned that financial markets could be "under-pricing risk" in an environment in which easy-money policies may have bred a false sense of security.

The potential growth of the global economy appears slower than a decade ago, so it is unlikely to go back to the rates achieved before the global financial crisis - even with the aid of monetary stimulus, it said.

An uneven global recovery is underway, said the IMF in its twice-yearly World Economic Outlook (WEO). In it, it revised down the 2014 growth forecast for the global economy from 3.7 per cent to 3.3 per cent; the forecast for next year is 3.8 per cent.

In the Global Financial Stability Report (GFSR) accompanying the WEO, the IMF noted the concern that markets are under-pricing risk, given the uncertainties in the macro-economic outlook and their implications for the withdrawal of monetary stimulus in major advanced economies.

The IMF said in the WEO that downside risks have risen since the spring, and that short-term risks include a worsening of geopolitical tensions, a reversal of recent risk spread and volatility compression in financial markets.

Medium-term risks include stagnation and low potential growth in advanced economies and a decline in potential growth in emerging markets.

Given such increased risks, raising actual and potential growth must remain a priority, the IMF said.

"In advanced economies, this will require continued support from monetary policy and fiscal adjustment attuned in pace and composition to supporting both recovery and long-term growth."

The report also suggested that there was a general, urgent need for structural reforms to strengthen growth potential or make growth more sustainable across all economies, be they advanced, emerging-market or developing ones.

Meanwhile, financial markets have been "optimistic," marked by high equity prices, compressed spreads and very low volatility, it said.

"However, this has not translated into a pickup in investment, which - particularly in advanced economies - has remained subdued."

Against this backdrop, geopolitical tensions have risen, noted the WEO. Their macro-economic effects appear mostly confined to the regions involved, but there are tangible risks of more widespread disruptions.

Six years after the global financial crisis, "global economic recovery continues to rely heavily on accommodative monetary policies in advanced economies to support demand, encourage corporate investment and facilitate balance sheet repair."

But although monetary accommodation remains critical in supporting the economy by encouraging economic risk-taking in advanced economies in the form of increased real spending by households and greater willingness to invest and hire by businesses, prolonged monetary easing may encourage excessive financial risk-taking. This would take the form of increased portfolio allocations to riskier assets and increased willingness to leverage balance sheets, the report suggested.

"Thus, accommodative monetary policies face a trade-off between the upside economic benefits and the downside financial stability risks."