UK AT RISK OF CREDIT CRUNCH, BANK OF ENGLAND WARNS

Financial markets are in danger of suffering a “sharp correction” that triggers a credit crunch, the Bank of England has warned, amid swirling fears of an AI tech bubble. 

Policymakers said stretched valuations left equity markets vulnerable to an economic shock which could drive up the cost of borrowing for households and businesses.

It comes against a backdrop of concerns about economic growth, escalating tensions in the Middle East and $1 trillion of bets against US bonds ahead of November’s election.

However, the Financial Policy Committee (FPC) said the fragility of financial markets was laid bare by August’s massive share sell-off which was triggered by concerns that the world’s biggest economy was headed for recession.

Doubts over an AI boom driven by investment by Microsoft, Google and others also fuelled the rout, with some $279bn (£210bn) wiped off the value of artificial intelligence giant Nvidia. Share prices have since largely recovered.

The FPC, which is responsible for financial stability, warned that a fresh economic or financial shock could trigger a crisis if firms were unable to meet cash calls.

Such margin calls were seen when pension funds were forced into a fire sale of assets in the wake of Liz Truss’s mini-Budget, pushing up borrowing costs for millions of mortgage holders.

The Bank warned that contagion in so-called repurchase markets – which allow banks to borrow cash quickly and cheaply when needed – could risk another lurch up.

The FPC warned that share price valuations remained “stretched”, adding: “Markets remain susceptible to a sharp correction, which could affect the cost and availability of credit to UK households and businesses.”

There are growing concerns that shares remain overvalued, with growing fears that the US tech boom will turn to bust. Goldman Sachs expressed concerns this summer over whether a $1 trillion in AI investment by the country’s tech giants will “ever pay off”.

While the sell-off in August proved to be short-lived, the Bank said the episode highlighted “material” global vulnerabilities. The FPC said it showed there was a “disconnect” between current lofty share valuations and concerns about global growth, with investors remaining jittery about both positive and negative economic news.

“Markets therefore remained susceptible to a sharp correction, with investors sensitive to developments in what remained a challenging global risk environment,” the FPC said.

The FPC, which is in charge of monitoring financial stability, added: “Investors [are] sensitive to short-term developments in a challenging global risk environment. Global vulnerabilities remain material, as does uncertainty around the geopolitical environment and global outlook.”

The FPC’s warning comes as Iran’s bombardment of Israel on Monday night pushed up oil prices and pushed US stock markets lower.

While investors have so far shrugged off concerns about the escalating war in the Middle East, the Bank’s latest systemic risk survey showed geopolitical political risk remained the top concern among finance executives, ahead of cyber attacks and a wider slowdown in the UK economy.

In brighter news for mortgage holders, the Bank highlighted that 1.7m people – roughly a fifth of borrowers – were already benefiting from the Bank’s decision to lower rates to 5pc from 5.25pc in August. Their borrowing costs are tied directly to the Bank’s base rate.

Policymakers highlighted that 3m more were due to refinance by 2027. While roughly 1.4m borrowers refinancing over the next year would see an average increase of £150 on their monthly payments, this is down from £180 a month extra from three months ago.

High street lenders have slashed their borrowing costs sharply in the wake of the Bank’s decision to reduce rates in anticipation of up to two more rate cuts this year.

The Bank also sounded the alarm over rising bets by hedge funds against US Treasuries, which have hit a new high of more than $1 trillion in recent months, up from a previous peak of $875bn (£659bn).

Policymakers warned that a number of factors could trigger a sudden unwinding of these trades, which “had the potential to amplify the transmission of a future stress”.

“It was important for financial institutions to be prepared for such severe but plausible stresses,” the Bank said.

Policymakers added that the fragility of financial markets was laid bare by August’s massive share sell-off. The rout was triggered by weaker-than-expected US jobs data and banks unwinding a so-called “yen carry trade” as an era of cheap borrowing in Japan came to an end.

While this episode of volatility proved to be short-lived, the Bank said it highlighted “material” global vulnerabilities. It also showed there was a “disconnect” between current lofty share valuations and concerns about global growth, with investors remaining jittery about both positive and negative economic news.

“Markets therefore remained susceptible to a sharp correction, with investors sensitive to developments in what remained a challenging global risk environment,” the FPC said.

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2024-10-02T11:02:24Z dg43tfdfdgfd