‘Market prices vulnerable to sharp correction,’ Bank of England warns
The Bank of England has warned that investors are only focusing on good economic news, sending up asset prices and raising the risk of a “sharp correction” in the future.
In its latest financial stability report, the Bank noted that risk premia had been “compressed for some time” but, in some markets, “have tightened even further” over the past few months.
This suggests that investors are increasingly willing to make risky bets, which Bank officials found particularly concerning given the range of global risks that remain.
The Bank pointed to the AI-driven rally in US equities, which has pushed US stock markets to record levels. The excess return on US equities relative to government bonds has increased to the levels seen in the early 2000s, just before the Dot Com Bubble.
Equity prices have also increased in the UK and EU since the Bank’s last financial stability report in December.
“The adjustment to the higher interest rates environment is not yet complete and markets prices remain vulnerable to a sharp correction,” the report warned.
The Bank drew attention to a couple of risks which could knock markets, including the “material” risks in the US commercial real estate market.
Political factors were also flagged as a danger. “Policy uncertainty associated with upcoming elections globally has increased,” the Bank added, warning that it could increase existing sovereign debt pressures and risks associated with geopolitical fragmentation.
If there were to be a sharp correction in asset prices, it would be much more difficult for businesses to refinance maturing debt, the report said.
Existing vulnerabilities in market-based finance, such as among private equity firms, could also amplify the correction if leveraged market participants face large losses.
Despite the Bank’s concerns about global financial markets, the domestic situation remains fairly stable reflecting an improving economic outlook.
Although mortgage arrears are expected to increase slightly over the coming months, they will remain well below financial crisis levels. Measures of corporate debt vulnerability have also fallen in recent months.
“Household and corporate borrowers as a whole have been resilient to higher interest rates,” the report said.
However, the Bank still warned that there were dangers. Just over 3 million people, around 35 per cent of borrowers, are currently on mortgage rates below three per cent.
These mortgages are due to reprice between now and the end of 2026, leaving households paying around £180 a month more.
The report confirmed that the banking sector is strong enough to support households even if the economy does worse than expected.