Bank of England issues caution about potential for global financial market turbulence following increase in summer volatility.
Unexpectedly weak U.S. jobs data and AI tech company results have led to a rise in economic volatility.
The Bank of England (BoE) has cautioned that global financial markets are susceptible to shocks following a “spike in volatility” during the summer.
Nevertheless, the UK banking system, according to the Bank’s Financial Policy Committee (FPC), is robust enough to endure tougher economic conditions.
The FPC identifies risks to financial stability and collaborates on policies to protect the resilience of the British financial system. In its latest report, the committee affirmed that the British banking system is dependable and capable of continuing to support households and businesses.
The review indicated that financial stability has remained unchanged since June, but the state of economies and global geopolitical developments remains at an elevated level.
This comes amidst the escalation of the conflict in the Middle East, following Iran’s attack on Israel. Heightened geopolitical risks, along with changes in demographics and climate, could increase pressure on major economies, potentially resulting in higher national debt and interest rate levels.
The FPC reported a “short-lived spike in volatility and drops in equity indices across global financial markets” in early August, triggered by disappointing U.S. job data and AI tech company results.
Furthermore, the shifting interest rate differentials between the United States and Japan have contributed to the increase in volatility. However, due to positive macroeconomic news that followed, most asset prices quickly returned to, or near, their initial levels.
Businesses and financial institutions need to be “prepared” for “severe but plausible stresses,” as warned by the FPC.
“Markets remain susceptible to a sharp correction, which could affect the cost and availability of credit to UK households and businesses, with investors sensitive to short-term developments in a challenging global risk environment,” emphasized the report.
Improving Outlook
The FPC has noted a continually improving economic outlook in the UK since its previous meeting at the end of June, reporting slightly stronger GDP and slightly lower inflation rates.
In August, the BoE reduced the borrowing costs from 5.35 to 5 percent, marking the first interest rate cut in over four years. Expected interest rate pathways, serving as anchors for mortgages, decreased by approximately 75 basis points compared to the previous quarter of this year.
The FPC affirmed that while some lower-income households and renters may face pressure, the overall resilience of mortgagors to higher interest rates is evident.
About a third of mortgage holders have yet to transition to higher interest rates. The report also highlighted that the percentage of individuals spending more than 70 percent of their income on mortgage payments is expected to remain stable.
UK businesses have shown resilience to higher interest rates, with corporate debt vulnerability significantly below pandemic peaks. Most insolvencies were seen among very small businesses corresponding to a small portion of bank debt.
“Firms in sectors like construction, wholesale and retail trade, and accommodation and food service activities accounted for about half of cases,” the report revealed.
Even in circumstances where economic and financial conditions deviate significantly from expectations, the UK banking system is capable of supporting households and businesses, according to the FPC.
Regarding risks to the economy from artificial intelligence, the committee stated that AI could both aid the markets and exacerbate existing risks.
The FPC declared its commitment to monitoring systemic risks posed by AI.
“Developing an effective monitoring framework to comprehend the most significant changes in the use and risks from AI was crucial to assessing how well these risks were captured in existing regulatory approaches,” the report concluded.
