Rising interest rates in advanced economies and a slowdown in emerging markets could combine to cut global growth by as much as 2%, the International Monetary Fund has warned.
Its latest report into how policy moves in one country can spill over into others also highlights the threat that tensions in Russia and Ukraine could send shockwaves through financial and commodity markets across Europe, central Asia and beyond.
The IMF's main concerns, however, centre around two key factors emerging as the global economy "shifts from crisis to recovery mode".
It highlights the challenge for central banks of smoothly unwinding the ultraloose monetary policy they brought in to support advanced economies during the financial crisis. Secondly, it warns that emerging market economies are slowing in a "synchronised and protracted manner" and that poses risks to the rest of the world in terms of trade and finance.
The report is the latest to emphasise the complex task of returning to more normal interest rates after years of extraordinary measures to shore up markets and confidence. In the UK, base rates have been at a record low of 0.5% for more than five years while in both the US and UK there have been vast money printing schemes, known as quantitative easing.
The IMF said there was a risk that rising interest rates could compound the pressure on the global economy from slowing emerging markets, where average GDP growth is projected to fall from 7% pre-crisis to 5% over the next five years.
"Markets may reassess growth prospects in emerging markets if there are renewed bouts of financial turbulence as advanced economies normalise monetary policy," said report author Hamid Faruqee.
"A downside scenario of sharply tighter financial conditions alongside a further weakening of emerging market growth would be damaging for the global economy – lowering output by about 2%," his report added.
The fund called for stronger policy action at both national and global levels to avert such a scenario.
But the report also says not all spillovers are negative and if financial conditions tighten for the right reasons the effects could be positive.
When advanced economies normalise monetary policy as their economic outlook improves, it will tend to tighten financial conditions globally, but the accompanying boost to growth should potentially offset the negative effects of tighter borrowing costs, the report said.
"In other words, faster growth in advanced economies – which translates into higher external demand – could be good for other economies, if managed well," it explained.
"On the other hand, if the tightening of monetary conditions is not driven by higher growth but is instead triggered by, for example, financial stability concerns, spillovers could have a negative impact on growth elsewhere, especially in vulnerable emerging economies."
It also warned about the swings in exchange rates between currencies if policy is tightened at different times in different countries. That appears to be a very real risk with the eurozone easing policy and the UK and US getting closer to tightening.
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