The Madrid attacks affected stock markets around the world

That is the gloomy conclusion of the International Monetary Fund (IMF), which has just published its bi-annual Global Financial Stability Report.

But putting the terrorism threat to one side, the report paints an upbeat assessment of the world economy.

Interest-rate rises might hit some shares, but the outlook remained good.

"It is clear that if there were more incidents along the lines of Madrid, it would have an impact on the real economy, consumer confidence would be hit," said Gerd Haeusler, the IMF's director of international capital markets.

Strong recovery

The report added: "At any sign of that risk materializing, foreign investors could demand a risk premium on dollar assets - including pushing bond yields higher and with more volatility than current market expectations."

At present, financial markets seem to be enjoying a 'sweet spot': economic activity and corporate earnings have made a strong recovery IMF report

Yet despite increased terrorism fears, the IMF said economic activity and corporate balance sheets had improved since September 2003.

And while interest rates are likely to rise from current historic lows, it said it did not expect this for some time yet, because of rising productivity and slack in the US economy.

The IMF also said it believed the dollar's "orderly adjustment" back upwards would continue, but warned of serious ramifications - and the need for action - if it did get out of step and drop abruptly.

But the Fund remained upbeat.

"At present, financial markets seem to be enjoying a 'sweet spot': economic activity and corporate earnings have made a strong recovery, most noticeably in the United States but also in other parts of the world," it said.