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Monetary policy must address 'frothy' financial markets, warns central bank body

  • The Bank for International Settlements (BIS) said investors were choosing to bask in the "light and warmth" of improving global growth, muted inflation and soaring stock markets
  • However, record high debt levels and the scale of this year's rally in asset prices are both reminiscent of the pre-2008 financial crisis era, according to the BIS
  • "Can a tightening be considered effective if financial conditions unambiguously ease? And, if the answer is 'no', what should central banks do?" Claudio Borio, head of the BIS's monetary and economic department, said in the report published Sunday.
Janet Yellen, Chair of the Federal Reserve, Mario Draghi, President of the European Central Bank (ECB), Mark Carney, Governor of the Bank of England, and Haruhiko Kuroda, Governor of the Bank of Japan, in a panel to discuss central bank communication on November 14, 2017 in Frankfurt, Germany.
Hannelore Foerster | Getty Images
Janet Yellen, Chair of the Federal Reserve, Mario Draghi, President of the European Central Bank (ECB), Mark Carney, Governor of the Bank of England, and Haruhiko Kuroda, Governor of the Bank of Japan, in a panel to discuss central bank communication on November 14, 2017 in Frankfurt, Germany.

Investors should be more concerned about an overheating financial market at a time when consumer debts are rising to unsustainable levels, according to the global body for central banks.

In its quarterly financial review, the Bank for International Settlements (BIS) said investors were choosing to bask in the "light and warmth" of improving global growth, muted inflation and soaring stock markets. However, record high debt levels and the scale of this year's rally in asset prices are both reminiscent of the pre-2008 financial crisis era, according to the BIS.

"The vulnerabilities that have built around the globe during the long period of unusually low interest rates have not gone away. High debt levels, in both domestic and foreign currency, are still there. And so are frothy valuations," Claudio Borio, head of the BIS's monetary and economic department, said in the report published Sunday.

'What should central banks do?'

In September, the Federal Reserve announced plans to start unwinding its massive balance sheet while the European Central Bank (ECB) is also poised to heavily cut its stimulus.

An improving global growth outlook and signals from both the Fed and ECB that they will look to adopt a cautious approach going forward was likely the explanation for stubbornly low yields, the BIS said, though it did also trigger a "deeper question."

"Can a tightening be considered effective if financial conditions unambiguously ease? And, if the answer is 'no', what should central banks do?" Borio said.

The BIS, known as the central bankers' bank, has 60 members and aims to help central banks pursue monetary and financial stability. It was one of the few organizations to warn investors about the unstable levels of bank lending on risky assets, such as U.S. subprime mortgages, that eventually led to the global financial crisis.

The organization's chief economist at that time, William White – who has since become the Swiss-based chairman of the OECD's review committee – reportedly said last year that global debt levels had skyrocketed to unstable levels in response to low interest rates and the financial situation was now "worse than 2007."

The national flag of Switzerland flies outside the headquarters of the Bank for International Settlements (BIS) in Basel, Switzerland.
Gianluca Colla | Bloomberg | Getty Images
The national flag of Switzerland flies outside the headquarters of the Bank for International Settlements (BIS) in Basel, Switzerland.

Martin Arnold, FX and macro strategist at ETF Securities, said Monday that investors still had a "polarized view" about the current financial conditions.

Arnold told CNBC that while some market participants were clearly "very, very concerned" about valuations, "everyone is still piling into equities."