BIS warns economic recovery faces pitfalls

The global economic recovery has taken a firm hold but faces many potential pitfalls which could derail or dampen it, the Bank for International Settlements (BIS) said yesterday.

Global inflation is expected to remain moderate in 2004 even as annual output growth rises to 4.5 per cent, driven by the United States and Asia, said the BIS, the central bank to the world's central banks.

"The consensus expectation is for steady and essentially non-inflationary growth, albeit subject to increasing geopolitical uncertainties," said the BIS in its annual report, which is watched to see how central banks view the world economy.

The BIS cited possible threats including inflation, asset price bubbles, indebted households, fiscal imbalances and the difficulties central banks face in reversing their expansionary monetary policies of the past three years, begun when they cut interest rates to the lowest levels in generations.

"The immediate challenge for very loose monetary and fiscal policies in the industrial countries must be to restore more normal policy conditions in a way that avoids catalysing instability in the face of the imbalances," the BIS said.

Analysts also worry that even slight tightening efforts by the US Federal Reserve, for example, could shake an economy fuelled by cheap credit, which has encouraged homeowners to take on debt to finance shopping sprees.

Households in industrialised countries have taken on increasing debt levels, in effect borrowing wealth from the future that must be paid back, likely in the form of lower spending, which could dampen a recovery, it said.

Turning to the biggest economies, the BIS said that the US, which has led the recovery with historically low interest rates and a huge fiscal stimulus plan, was unlikely to be threatened by inflation soon.

Japan should exceed most estimates for potential growth in 2004 after entering the year with strong momentum, said the report.

"In China, over-investment, weakness in the banking sector and higher inflation are the sources of concern," the BIS said.

Continental Europe is lagging the rest of the industrialised world as domestic demand remains weak, the BIS said, suggesting structural reforms could yield profound benefits. "The conditions are not yet in place in the euro area, which is forecast to continue lagging the global upturn," the BIS said.