Financial markets may be underpricing global risks, leaving them vulnerable to a major correction, according to European Central Bank Governing Council member Klaas Knot warned.
As global stocks surge, measures of volatility suggest unprecedented calm even as crises around the world — including the Catalan separatists in Spain, Turkey’s diplomatic row with the U.S., North Korea’s missile tests and the danger of a hard Brexit — make political headlines.
“It increasingly feels uncomfortable to have low volatility in the markets on the one hand while on the other hand there are risks in the global economy,” said Knot, who is also the president of the Dutch Central Bank.
Similarly, a sooner-than-expected normalization of U.S. monetary policy — where financial markets see a slower pace of rate hikes than what the Federal Reserve communicates — would quickly turn investor sentiment, the DNB wrote in a report on financial stability which Knot presented in Amsterdam on Monday. That makes the “risk of sharp market corrections real,” it said.
Still, Knot said there’s “no one within the context of the ECB already talking about an increase of interest rates. Rates will “stay low for a long time.”
In the run-up to the next policy decision on Oct. 26, ECB officials are showing differing preferences for the way forward with quantitative easing, which is set to run at 60 billion euros a month and total almost 2.3 trillion euros by the end of December. Executive Board member Peter Praet, who crafts the policy proposals, said last week that calm markets may allow the final stages of the bond-buying plan to be dragged out.
“The program has achieved what realistically could be expected from it,” Knot said about QE, adding that it supported growth, reduced investment costs and ended deflationary risks.
The deliberations over whether to slow asset purchases are colored by the fact that inflation continues to lag behind the ECB’s goal of just under 2 percent and its own projections don’t see that being achieved until at least late 2019.