By Marc Jones
LONDON (Reuters) - The Bank for International Settlements has urged central banks to outline how they plan to reel in coronavirus support measures, but also warned that financial markets may have become too complacent about the scale of the crisis.
The Basel-based central bank umbrella group said in its annual report published on Tuesday that the unprecedented "sudden stop" caused by the pandemic was evolving from a liquidity problem into a more fundamental threat to firms' solvency.
"The pandemic is the defining event of a generation," BIS General Manager Agustín Carstens said.
The long-term viability of many companies will be tested in the next phase of the crisis, the report says, with the strength of the recovery depending on the evolution of the pandemic and how much damage it leaves in its wake.
The IMF slashed its global economic forecast to a near 5% contraction earlier this month, which if realised, would be the worst downturn since the Great Depression of the 1930s. The number of COVID-19 cases has now topped 10 million.
"Central banks are fully aware of the challenges ahead as the outlook for the world economy is still highly uncertain. Some of these challenges extend beyond their mandate," Carstens added.
The success in calming markets and shoring up confidence has, however, helped fuel market "exuberance". World stocks are set for their best quarter in 16 years and Wall Street for its best since 1998.
"Equity prices and corporate spreads in particular seem to have decoupled from the weaker real economy" and "underlying financial frugalities remain," the BIS said.
A wave of credit rating downgrades has already started -- S&P Global alone has taken around 2,000 negative rating actions since the crisis erupted -- and there are concerns that losses might lead to widespread defaults.
"This feels more like a truce than a peace settlement," the report said of the current situation.
(Graphic: Timeline of the coronavirus support measures from central banks and governements, https://fingfx.thomsonreuters.com/gfx/mkt/nmovajqzepa/Pasted%20image%201593510269841.png)
Despite acknowledging the virus was far from defeated, Carstens said central banks needed to prepare markets for the removal of crisis support measures once the situation begins to normalise.
Global central banks have made roughly 150 interest rate cuts this year, while BofA estimates that there has been a combined 18 trillion dollars worth of monetary and fiscal aid ploughed into the world economy.
"The exit strategy is a difficult discussion, nevertheless it needs to be considered," Carstens told Reuters, saying the market needed to know the extra stimulus would not be there forever.
Governments will have to continue to help though and the assumption remains that inflation is likely to be pushed up by all the extra money being shovelled into the system.
A more concerning scenario would be the creation of a post-Second World War type situation should a lengthy pandemic leave a much larger imprint on both the global economy and the political sphere.
"In this world, public sector debt would be much higher and the public sector’s grip on the economy much greater, while globalisation would be forced into a major retreat," the BIS said.