Global liquidity remains high despite rate rises, says OECD

Paris, Nov 28 | Updated: Nov 29 2006, 09:25am hrs
Liquidity in world financial markets remains abundant despite recent interest rate rises and is still above historical norms, the Organisation for Economic Cooperation and Development said on Tuesday.

Although monetary policies have been tightened across the globe, liquidity is still abundant and financial market conditions have remained supportive to date, the OECD said in its twice-yearly Economic Outlook. The Paris-based group linked high asset prices in recent years to low interest rates and liquidity fed by the build-up of official dollar reserves.

This may have made investors less concerned about risk, illustrated by the fall in emerging market bond spreads from around 400 basis points in mid-2005 to around 200 basis points.

Were monetary conditions to tighten significantly and liquidity to contract, risk premia might conceivably widen abruptly, the report said, but added: Such concerns have not been validated so far and may not be in the near future.

The OECD said it was difficult to establish exactly how much liquidity was outstanding. But it appears that global liquidity has not yet started to decelerate, let alone contract, and, as gauged by money and credit-based measures, it is still well above historical norms.

It said the inversion in the yield curve in US bond markets should not be seen as an indication that financial market participants expect a recession. A number of structural factors have contributed to lower the term premium to a point where even small short-term effects on bond yields can lead to an inverted yield curve, it said.

These include better anchored inflation expectations, high savings and foreign reserve accumulation in emerging Asian economies, recycling of petrodollars and portfolio shifts by pension funds towards bonds to meet impending retirement obligations.