GENEVA — Solid growth by the U.S. and China, along with a recovery in Japan and expansion in Germany, bodes well for the performance of the world economy, according to the Bank for International Settlements.

“The global economy continues to grow exceptionally strongly, perhaps generating a dynamic that will prove hard to control,” the BIS said in its annual report published Monday. “As a result of this broadening expansion, trade imbalances could also be lowered.”

In addition, the BIS said, “Global inflation is forecast to remain generally subdued. Financial markets seem to have shared this optimism.”

However, the Basel, Switzerland-based BIS, an international organization that fosters international monetary and financial cooperation and serves as a bank for central banks, cautions that Asian central banks — in particular China, which last year added another $209 billion in reserves — need to do more to appreciate their currencies to help reduce large structural imbalances.

The BIS report points out that, while some Asian central banks recognize this, “China remains an exception.”

Greater currency flexibility by China and elsewhere in Asia suggests the BIS, “would be welcome, given general concerns about domestic overheating, as well as worries about investment misallocation.”

Wages in China’s powerhouse economy, and in some other emerging market economies, notes the BIS “have been trending upwards and Asia as a whole seems to be facing increasing inflationary risks.”

The BIS notes the principal concern in China is that “misallocated capital will eventually manifest itself in falling profits and that this will feed back on the banking system, the fiscal authorities and the prospects for growth.”

Such a development, the BIS warns, “might have severe effects” on industrial countries, as in such circumstances China’s already formidable manufacturing potential “would surely be directed still more to export markets.”

Such a scenario, the BIS said, while currently low, could present “a great challenge” for other countries.

Moreover, the risk of further depreciation of the dollar could also exacerbate inflationary pressures, the BIS said, and observed that the strength of the currency, until recently, in the face of a record external deficit and “unprecedented household debt accumulation, remains hard to explain.”

This story first appeared in the June 27, 2006 issue of WWD. Subscribe Today.

Finally, the report argues that, in past dollar depreciations, exporters to the U.S. were able “to cut costs, preserving margins and reducing pass-through,” and adds, “It could, if repeated, be a further impediment to the U.S. current account adjustment.”

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