BIS warns of global risks from debt, AI boom, and fragilities

The report detailed a challenging landscape characterized by strained fiscal positions, the persistent threat of supply shocks, and the potential for a resurgence of stubbornly high inflation. While acknowledging recent resilience in economic activity, the BIS stressed that policymakers must act decisively to safeguard global stability. BIS General Manager Pablo Hernandez de Cos stated that policy actions need to be coordinated to avoid conflicting pressures on the global economy, underscoring the critical importance of sound fiscal and financial foundations.

Four primary pressure points were identified. Inflation has shown signs of picking up again, with the BIS cautioning that more frequent supply disruptions could lead to inflation expectations becoming deeply entrenched. De Cos indicated that central banks are prepared to act if they observe such anchoring of inflation expectations. He also noted that a recent ceasefire in the Middle East and the reopening of the Strait of Hormuz were positive developments, suggesting that extreme scenarios were likely to be avoided, though oil market normalization would take time.

The report also expressed uncertainty about the long-term durability of the current surge in AI-related investment. While AI has boosted confidence and growth expectations through potential productivity gains, the BIS warned of rising job anxieties and the possibility of overinvestment, mirroring past boom-and-bust cycles, due to supply bottlenecks and intense competition. For central banks, AI presents fundamental questions about the future functioning of the economy, though de Cos advised against prescriptive reactions at this stage.

Financial vulnerabilities remain a significant concern. Elevated asset valuations and a degree of investor complacency have left core bond markets in a more fragile state. Furthermore, the financing of the AI boom is increasingly reliant on debt and complex funding structures throughout the supply chain. Compounding these issues are record-high public debt levels and sovereign debt markets increasingly dominated by large, highly leveraged hedge funds, creating what the BIS termed a "new sovereign-financial stability nexus."

Frank Smets, acting head of the BIS monetary and economic department, explained that this nexus could lead to more frequent and sharper declines in sovereign bond values, potentially tightening financial conditions rapidly. De Cos reiterated the BIS's message of "urgency" regarding the need to reduce debt levels in key economies, particularly as debt is increasingly financed through non-bank financial intermediaries. The BIS recommended that policymakers prioritize price stability, ensure fiscal sustainability, enhance coordination and oversight beyond traditional banking sectors, and implement structural reforms, warning that delays would only increase the cost of necessary adjustments.