International banking regulator calls for rates to be raised worldwide

Central banks around the world must raise interest rates soon to bring inflation under control, international regulators have warned.

The Bank for International Settlements (BIS) – the central bank for central bankers – said, in its annual report published on Sunday, that the era of loose monetary policy must end.

"Tighter global monetary policy is needed in order to contain inflation pressures and ward off financial stability risks," the BIS said, adding that rates may need to be raised more rapidly than after previous recessions.

It levied particular criticism at the Bank of England's monetary policy committee (MPC), which has maintained UK interest rates at their current record low of 0.5% since March 2009.

"In the United Kingdom, CPI inflation had exceeded the Bank of England's 2% target since December 2009, reaching a peak of 4.5% in April 2011 (in part due to a VAT increase). As yet, there has been no move by the MPC, but one wonders how long its current policy can be sustained," the BIS said.

City economists increasingly believe the MPC will resist raising interest rates during 2011.

The BIS acknowledged that "policymakers and households have virtually no room for manoeuvre" because of the unsustainably high levels of debts run up by both countries and individuals.

However, it continued: "All financial crises, especially those generated by a credit-fuelled property price boom, leave long-lasting wreckage. But we must guard against policies that would slow the inevitable adjustment. The sooner that advanced economies abandon the leverage-led growth that precipitated the Great Recession, the sooner they will shed the destabilising debt accumulated during the last decade and return to sustainable growth. The time for public and private consolidation is now.

"The logical conclusion is that, at the global level, current monetary policy settings are inconsistent with price stability."

The BIS is also clear that the overly indebted countries in the eurozone need to tackle their problems. It believes the boom also masked serious long-term fiscal vulnerabilities that, if left unchecked, could trigger the next crisis.

"We should make no mistake here: the market turbulence surrounding the fiscal crises in Greece, Ireland and Portugal would pale beside the devastation that would follow a loss of investor confidence in the sovereign debt of a major economy," it said.

International banking regulators, also agreed over the weekend that the biggest banks in the world – probably including HSBC and Barclays – should be forced to hold more capital than those less likely to send a shock wave through the financial system in the event of their failure.

Those banks which are potentially too big to fail will be required to have a core tier one ratio – a measure of their assets against the risks they run – of 9.5% compared with the 7% minimum for systemically less important banks.

"The agreements reached will help address the negative externalities and moral hazard posed by global systemically important banks," said Jean-Claude Trichet, the European Central Bank president, who is retiring. The Bank of England governor, Sir Mervyn King, will succeed him in the role of overseeing the supervisory group that sets bank capital.

The floor of 9.5% was announced at a meeting of international banking regulators in the Swiss city of Basel. If the biggest banks get even larger, then they may be forced to raise their capital cushions to 10.5%. Financial institutions have already begun to accumulate capital since the banking crisis, when banks such as Royal Bank of Scotland were running on water-thin capital ratios of 2%. For instance, Bob Diamond, chief executive of Barclays, recently set out a strategy for the bank on the basis that it would be able to operate on a 10% capital cushion – the level suggested by Sir John Vickers in his recent interim report into the UK banking sector.

Details of which banks are classed as "global systemically important financial institutions" will be released later this year.