The global downturn may be deeper and longer than markets and economists have so far predicted while rising inflation may be stronger and more persistent, one of the world’s leading official financial bodies said today.

The Bank for International Settlements (BIS) today warned that conflicting pressures from a more severe worldwide slowdown alongside stubbornly high inflation are set to aggravate the already sharp dilemmas confronting central banks on both sides of the Atlantic.

In a grim assessment, the annual report of the Basle-based BIS, known as “the central banks’ central bank”, also sounds a warning that the toll from the global credit squeeze could also mount, and become more painful than most forecasts from the City and Wall Street have suggested.

Yet the BIS concludes that, despite this, mounting inflationary forces in the leading Western economies may still force central banks, from the Federal Reserve to the Bank of England and European Central Bank, to raise interest rates despite this and the danger of a deeper than predicted world downturn.

“With inflation a clear and present threat, and with real policy [interest] rates in most countries very low by historical standards, a global bias towards monetary tightening would seem appropriate,” it concludes.

“Inflation risks are greater than they have been for many years.”

It emerged today that 12-month inflation across the Eurozone's 15 member countries hit a record 4 per cent in June, an increase from the 3.7 per cent recorded the previous month.

There is also mounting speculation that the Bank of England’s next move could be to raise rates later this year.

Today’s hard-hitting BIS report argues that after a long global boom driven by possibly excessive growth in credit and lending, it should not be surprising “to see turmoil in financial markets, slowing real growth an temporarily rising inflation”.

In a bleak finding, it concludes that the combined impact of these negative factors “does appear to point to a deeper and more protracted global downturn than the consensus view seems to expect”.

At the same time, the BIS sounds the alert over inflation risks, warning that “inflation risks, particularly in emerging market economies, could also prove unexpectedly strong and persistent”.

Although the report finds that this points to a likelihood that interest rates in leading economies may have to rise, the BIS says that varying circumstances rule out a “one size fits all” approach. Should the world downturn proves markedly worse than expected this could remove the need for dearer borrowing costs, it adds.

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