FRANKFURT: US rate hikes could have greater global repercussions than in the past and affect the euro zone more in some respects than the domestic market, European Central Bank Vice President Vitor Constancio said on Thursday.

A Federal Reserve rate rise would have a bigger impact because emerging markets, particularly China, are more integrated into the global economy than before, countries are more interlinked in production, cross-border capital flows have increased, and forward guidance has become a crucial monetary policy instrument, Constancio said.

The Fed skipped a chance to hike rates in September but policymakers have repeatedly said the United States is on course for a hike later this year with some suggesting a move as soon as October.

An additional hurdle is that central banks do not have experience in raising interest rates from an extended period at zero, so they will have to learn through practice, without a full understanding of how economies and markets may respond, Constancio told a conference in Hong Kong.

The biggest global impact of a Fed hike will be through capital markets, not international trade, and German yields already follow the change of US yields in response to Fed tightening by more than one third, Constancio said.

“Overall, the evidence even suggests that spillovers from US monetary policy might be larger (on the euro area) than the domestic effects in the US,” Constancio said.

While diverging monetary policies reflect differences in fundamentals in the eurozone and the United States and the traditional view is that this should create no problems, “this time the divergences could have greater global repercussions than in the past”, Constancio said.

Given the dollar’s rise in international capital markets and the market’s integration, there’s no institution large enough to handle extreme stress and it is a mistake to think central banks can solve all problems.

“With huge amounts of debt in US dollars being created around the world without liquidity backstops, we are still far from having a global lender of last resort adequate for our times,” Constancio said.

“The global economy has become more vulnerable than ever before to very large real and financial spillovers,” he added.

Published in Dawn, October 16th, 2015

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