Zurich - AFP
Loose monetary policies have created an "illusion of permanent liquidity" that is spurring investors to make risky bets and push up asset prices, the Bank for International Settlements said Sunday.
"The longer the music plays and the louder it gets, the more deafening is the silence that follows," Claudio Borio, who heads the BIS's monetary and economic unit, told reporters.
"Markets will not be liquid when that liquidity is needed most," he warned, urging "sound prudential policies (and) extra prudence on the part of market participants themselves".
Many central banks have kept their rates at record lows and pumped their economies full of liquidity first to stave off recession during the financial crisis and then to boost recent anaemic economic growth.
This month the European Central Bank cut its key interest rates to new all-time lows and promised to launch a programme of asset purchases to inject cash into the eurozone's stalling economy.
The BIS, the so-called central bank to the world's central banks, has long warned such moves are whetting investors' appetite for short-term, high-risk investments and froth in property markets, potentially creating the bubble conditions for a new market crash.
Borio said that markets have shown "exceptionally subdued volatility" at levels similar to before the financial crisis in recent months, which could be "a sign of high risk-taking".
Unease over the conflicts in Ukraine and the Middle East can caused a spike in volatility in early August, but that has since died down and "the search for yield has resumed in force," he said.
Borio stressed that "a common mistake is to take unusually low volatility and risk spreads as a sign of low risk when, in fact, they are a sign of high risk-taking".
"The illusion of permanent liquidity is just a prevalent now as in the past," Borio said, pointing out that years of "unusually accommodative" monetary policy has left investors feeling secure low interest rates would continue or only be gradually tightened.
That confidence has also spread to the international banking industry, where claims rose by $580 billion between January and March, BIS said.
That marked "the first substantial quarterly increase since late 2011," it said.
While this was not enough to offset preceding quarterly declines, it halved the year-on-year drop from 4.0 percent at the end of 2013 to 2.0 percent at the end of March, the report said.