More attacks like the Madrid train bombs could destabilise global financial markets and pose a significant threat to their otherwise steady recovery, the International Monetary Fund (IMF) warned today.
Though the economic outlook is largely benign, markets are also vulnerable to higher interest rates and shocks from global imbalances like the gaping US current account deficit, which could hit the dollar.
Economic activity has picked up and corporate balance sheets have strengthened since September, the IMF said in a cautiously optimistic Global Financial Stability Report. But attacks like those in Madrid could throw a spanner in the works.
"It is clear that if there were more incidents along the lines of Madrid, it would have an impact on the real economy, consumer confidence would be hit," Mr Gerd Haeusler, the IMF's director of international capital markets, said at a news conference in London.
"I would be somewhat concerned that an additional risk premium would be built into some asset classes that would be quite unwelcome."
Eventual rises in borrowing costs also pose a risk, increasing bond market volatility as investors revise their interest rate outlook, the IMF said. Yet, with inflation down - sustained by rising productivity and slack in the economy - interest rates should stay low for some time, it said.
The IMF warned that global imbalances needed attention, with markets focused on huge capital flows to the United States as Asian central banks intervene in foreign exchange markets to buy dollars.
Financial markets are uneasy about the possibility that Asia might slow or halt its currency purchases, which would flood the market with dollars and may force US rate rises to fend off inflation.
The IMF said it expected the "orderly adjustment" of the dollar to continue but warned of serious ramifications if it got out of step and dropped abruptly.
The IMF urged a "strong and sustained cooperative effort" to ensure a smooth adjustment of global imbalances, noting that this will remain a key policy priority for the international community. It also said low interest rates had encouraged an abundance of liquidity and risk-taking by investors.