Thursday, June 27, 2024 10:40 a.m
The Bank of England has warned that investors are focusing only on good economic news, sending asset prices up and raising the risk of a “sharp correction” ahead.
In its latest financial stability report, the bank noted that risk premiums had been “compressed for some time” but had “tightened further” in some markets over the past few months.
That suggests investors are increasingly willing to take risky bets, which bank officials saw as particularly worrisome given a number of lingering global risks.
The bank pointed to an AI-driven rally in US stocks that pushed US stock markets to record highs. The excess return on US stocks relative to Treasuries has risen to levels seen in the early 2000s, just before the Dot Com bubble.
Share prices have also risen in the UK and EU 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 highlighted several risks that could knock markets down, including “material” risks in the US commercial real estate market.
Political factors were also identified as a danger. “Political uncertainty linked to upcoming elections has increased worldwide,” the bank added, warning that this could add to existing sovereign debt pressures and risks associated with geopolitical fragmentation.
If there was 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 financing, such as among private equity firms, could also fuel a correction if leveraged market participants face large losses.
Despite the Bank’s concerns about global financial markets, the domestic situation remains relatively stable, reflecting the improving economic outlook.
Although mortgage arrears are expected to rise slightly in the coming months, they will remain well below financial crisis levels. The level of corporate debt vulnerability has also decreased in recent months.
“Households and corporate borrowers as a whole have been resilient to higher interest rates,” the report said.
However, the bank still warned that there was danger. Just over 3 million people, around 35 per cent of borrowers, currently have mortgage rates below three per cent.
These mortgages are due to be repriced 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 is doing worse than expected.