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QE Causing Riskier Investments, Bubble Looms: BIS

Equity and fixed income prices have reached unusually high levels that don't reflect the current weakening in the global economy, according to the Bank of International Settlements, leading to concerns of a fresh credit bubble.

Gregoria Gregoriou Crowe | Flickr Open | Getty Images

Further quantitative easing (QE) by the major central banks appears to have encouraged investors to take on more risk to find higher yields, according to the BIS, and sales of riskier types of bonds have increased in the last three months.

"Some asset prices started to appear highly valued in historical terms relative to indicators of their riskiness," it said in its quarterly review.

"Market participants attributed a significant part of the rally in asset prices to further loosening by central banks, notably the Federal Reserve."

The Fed announced on September 13 that it will buy $40 billion of mortgage-backed securities per month in an attempt to incubate a housing market showing flickering signs of recovery. Chairman Bernanke stipulated that the purchases be open-ended, meaning they will continue until the Fed is satisfied that economic conditions, primarily in unemployment, improve.

Similar measures have been used recently by the European Central Bank, the Bank of Japan and the Bank of England. The BIS warned that corporate bonds were near their pre-crisis levels but with default rates higher than they were in 2007.

"Numerous bond investors said that they felt less well compensated for risk than in the past, but that they had little alternative with rates on many bank deposits close to zero and the supply of other low-risk investments in decline," it said.

(Read More: Bernanke's 'Ruinous' QE Will Lead to Rapid Inflation: SocGen's Albert Edwards)

The Bank for International Settlements - noted to have predicted the financial crash back in 2006 - said that investment grade, sub-investment grade and emerging market bonds had fallen to their lowest levels since 2008. And mortgage bonds had reached their lowest level ever.

The International Monetary Fund trimmed its 2012 and 2013 global growth forecasts back in October. It now expects the world economy to grow 3.3 percent this year, down from the 3.5 percent growth it predicted in July. And projected growth for next year fell to 3.6 percent, down from 3.9 percent.

(Read More: Why a Spike in US Bond Yields May Be Coming)

Despite this change in forecast the BIS say it hasn't caused a risk-on environment and the price of risky assets has risen in the three months to early December.

"If you didn't have the Fed constantly buying down things and leading the way for other investors to follow yields lower, technically yields should be going up," Mike Thompson, head of global markets intelligence at S&P Capital IQ told CNBC Tuesday.

John Wraith, a fixed-income strategist at Bank of America Merrill Lynch, told CNBC Tuesday that the BIS was hinting at the possibility of a dangerous bond bubble with consequences that the financial world has seen many times before.

"You can go right down to the sovereign debt that is the focus of QE and say that yields in the U.S. or the U.K. or arguably Germany don't reflect the fundamentals and then look at the way that this money central banks have printed has spilt out into other asset markets," he said.

Contact World Economy

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