The Switzerland-based Bank for International Settlements (BIS) has warned that ultra-low interest rates have lulled governments and markets “into a false sense of security”.
The BIS – usually dubbed the “central banks’ central bank” – urged policy makers to begin to normalize rates.
“The risk of normalizing too late and too gradually should not be underestimated,” the BIS said.
Markets have rallied since January.
The FTSE all-world share index is up 5% so far this year, while the VIX, a measure of implied US market volatility known as the “fear index”, is at a seven-year low.
“Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally,” the BIS said in its annual report.
The BIS said that low interest rates had helped increase demand for higher risk investments on stock markets as well as in property and corporate bonds markets.
The organization doesn’t set policy but serves as a forum for central bankers to exchange views on relevant topics from the global economy to financial markets.
While global growth has improved, the BIS said it was still below its pre-crisis levels.
“Growth has disappointed even as financial markets have roared: The transmission chain seems to be badly impaired,” the BIS said.
It said policy makers should take advantage of the current upturn in the global economy to reduce the emphasis on monetary stimulus.
And it warned that taking too long to do this could have potentially damaging consequences, by encouraging investors to take too much risk.
“Over time, policies lose their effectiveness and may end up fostering the very conditions they seek to prevent,” it said.
“The predominant risk is that central banks will find themselves behind the curve, exiting too late or too slowly,” the BIS added.
The BIS was founded in 1930 and is the world’s oldest international financial institution. Its 60-strong membership includes the Bank of England, the European Central Bank, the US Federal Reserve, the People’s Bank of China and the Bank of Japan.