Rate rises pose risk to financial stability, says IMF

LONDON - Bigger than expected rises in long-term interest rates, or a sharp fall in the US dollar, pose risks to a financial system that is at its most resilient in a long time, the International Monetary Fund said on Tuesday.

In its global financial stability report, the IMF urged central banks to continue gradually raising interest rates toward a neutral level as a policy measure to help mitigate potential risks from excess liquidity.

"The key risk is that long-term market rates and credit spreads may rise beyond current expectations", said Gerd Haeusler, director of international capital markets at the IMF, calling the state of financial stability "as good as it gets".

"While financial markets have largely priced in a moderate and gradual monetary tightening they might be less prepared if market rates -- especially long-term rates -- were to go up more abruptly," the IMF report said.

The US Federal Reserve has so far lifted base rates gradually to tamp down future inflation, although most analysts agree they still have a way to climb before they reach a level where they neither stimulate nor restrict the economy.

In the meantime, sustained rises in commodity and oil prices -- US crude oil futures hit a record high above US$58 ($83.05) a barrel on Monday -- remain a risk to financial stability.

But IMF deputy director for international capital markets Hung Tran said that the impact from high oil prices has been "quite limited".

The IMF also reiterated that a potential disorderly correction in currency markets, particularly should Asian central banks' appetite for holding US dollars wane, was an ongoing risk.

So far, currency moves to address global imbalances have been orderly but there is a risk that could change.

"Any serious doubts about the willingness of central banks to accumulate dollars could spark strong incentives for investors, private and possibly even public, to reduce future dollar purchases or even reduce their existing dollar holdings," the report said.

"This could trigger a further significant decline of the dollar and an increase in US interest rates that might reduce US domestic demand."

Haeusler reiterated the IMF view that Asian central banks would do well to move toward letting fixed currencies float.

"We believe that it is in the interest of these Asian central banks ... to loosen up the corset of their fixed exchange rates," he said.

The IMF also singled out as a risk the proliferation of various complex financial instruments like credit derivatives and collateralised debt obligations which are in wide use but have not yet been tested in a financial stress situation.

While these instruments are traded in secondary markets, they are priced, bought and sold according to models that are likely commonly shared among a wide array of investors.

"Therefore, there is a risk that models that are overly similar in their construction could cause investors to rush to exit at the same time, leading to market liquidity shortages, " the IMF report said.

The IMF said that sharp house price rises in the Netherlands, the United Kingdom and in parts of the United States have raised concerns about excessive valuations.

Higher associated debt levels have increased households' exposure to house price moves, particularly among first-time buyers.

"Households may be exposed in many countries to the risk of significant underperformance in the medium (or longer) term if current prices turn out to be unsustainably high," the IMF said.

Emerging markets so far have benefited from improved financing conditions over the past two years, which have stemmed in part from increased global liquidity but also from increased reliance on domestic capital markets, the IMF said.

But it also said that many emerging markets "continue to face considerable maturity and currency mismatches on their balance sheets."

"Emerging market corporates, therefore, remain vulnerable to interest rate and foreign exchange risks which so far have tended to materialise together."

- REUTERS