‘Market prices vulnerable to sharp correction,’ warns the Bank of England

Thursday, June 27, 2024 10:40 am

The Bank of England today published its financial stability report.

The Bank of England has warned that investors are focusing solely on good economic news, causing asset prices to rise and increasing the risk of a “sharp correction” in the future.

In its latest financial stability report, the Bank noted that risk premia have been “low for some time” but have “tightened further” in some markets in recent months.

This suggests that investors are increasingly willing to make risky bets, which was especially worrying given the wide variety of global risks that still exist.

The Bank pointed to the AI-driven rally in US stocks, which has pushed US stock markets to record levels. Excessive returns on US stocks relative to government bonds have risen to levels seen in the early 2000s, just before the Dot Com bubble.

Share prices in the UK and the EU have also risen since the Bank’s last financial stability report in December.

“The adjustment to the higher interest rate environment is not yet complete and market prices remain vulnerable to a sharp correction,” the report warned.

The Bank drew attention to a number of risks that could shake markets, including ‘material’ risks in the US commercial real estate market.

Political factors were also identified as a danger. “Policy uncertainty related to the upcoming elections globally has increased,” the Bank added, warning that this could increase existing pressures on sovereign debt and risks associated with geopolitical fragmentation.

If there were a sharp correction in asset prices, it would be much more difficult for companies to refinance maturing debt, the report said.

Existing vulnerabilities in market-based financing, such as in private equity firms, could also amplify the correction if leveraged market participants suffer large losses.

Despite the Bank’s concerns about global financial markets, the domestic situation remains fairly stable, reflecting the improving economic outlook.

Although mortgage arrears are expected to increase slightly in the coming months, they will remain well below the level of the financial crisis. Measures of corporate debt vulnerability have also fallen in recent months.

“Households and businesses taking out loans have generally proven resilient to higher interest rates,” the report said.

However, the Bank still warned that there were dangers. Just over 3 million people, about 35 percent of borrowers, currently have mortgage rates below three percent.

These mortgages will be repriced between now and the end of 2026, causing households to pay around £180 more per month.

The report confirmed that the banking sector is strong enough to support households even if the economy performs worse than expected.

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