Economic downturns are at risk of becoming more severe as a result of prolonged low interest rates, the deputy governor of the Bank of England has warned.
The current environment of ‘low for long’ interest rates will make “demand management of the economy more difficult in downturns”, according to Jon Cunliffe.
The Threadneedle Street official flagged a series of challenges for financial stability in the wake of recent monetary policy shifts.
Cunliffe said that a “slow or an unwilling adjustment” to weaker returns from lower interest rates could lead to both greater risk taking and less resilience among companies in the financial sector.
“In short, the adjustment to a low for long world is likely to lead to upward pressure on financial sector risk taking and downward pressure on resilience. We have started to see evidence of these effects in some sectors. One would expect such pressures to continue,” Cunliffe said in a speech to the Society of Professional Economists in London.
He added: “A low for long world is likely to be a more challenging environment for financial stability. The first and, in my view, most important policy conclusion to draw from this is the need for active and powerful macro-prudential institutions and policy.”
European economies have been adjusting to a downward push in interest rates, as central bankers attempt to rejuvenate markets that have been slowing down in the last 12 months.
Last month the European Central Bank (ECB) embarked on fresh stimulus measures to boost the eurozone, including cutting a key interest rate.
Cunliffe, who is among the contenders to replace Mark Carney as the next BoE governor, did not address Brexit or the BoE’s near-term policy plans in his speech.
However, he added that “releasing buffers can have a powerful effect in a downturn by reducing the pressure on banks to cut back on lending and so avoid a credit crunch amplifying the macro-economic shock.”
“The question perhaps is whether that buffer needs to be made more powerful in a low for long world given the greater risk of severe downturns.”