Central banks must not let inflation become entrenched as the threat of stagflation looms over the global economy, the Bank for International Settlements warned on Sunday in its annual economic report.

BIS, considered the central bank of central banks, said institutions will have to move swiftly to ensure a return to low and stable inflation, while limiting the impact on growth.

"The key for central banks is to act quickly and decisively before inflation becomes entrenched," said BIS general manager Agustin Carstens.

"If it does, the costs of bringing it back under control will be higher. The longer-term benefits of preserving stability for households and businesses outweigh any short-term costs."

BIS's flagship report said that in restoring low, stable inflation, central banks should seek to minimise the hit to economic activity, in turn safeguarding financial stability.

BIS said engineering a so-called soft landing had historically been difficult, and that the starting conditions now made the task all the more challenging.

"It would be more desirable if we could have a soft landing because that would mean that the tightening of monetary policy could be more subdued," Carstens told a press conference.

"But even if this is not the case, definitely the priority should be to combat inflation," to prevent the world economy from slumping.

After the shock of the Covid-19 pandemic, central banks initially saw the return of inflation as temporary as the economy picked up again.

But the rise in prices has sharply accelerated since Russia's military campaign in Ukraine began in February.

BIS said the global economy risked entering a new era of high inflation.

The dangers of stagflation – stagnant growth coupled with rising prices – loom large, as a combination of lingering disruptions from the pandemic, the war in Ukraine, soaring commodity prices and financial vulnerabilities cloud the outlook, it added.

The European Central Bank plans to raise interest rates in July and then again September, while the US Federal Reserve on Wednesday carried out its largest rate hike since 1994. (AFP)