Bank of England Warns of Global Financial Market Shocks After Summer Volatility Spike

A general view of the Bank of England in London on Sept. 21, 2023. Aaron Chown/PA

The Bank of England (BoE) has warned that global financial markets are vulnerable to shocks after a “spike in volatility” over the summer.

However, according to bank’s Financial Policy Committee (FPC), the UK banking system is resilient enough to withstand tougher economic conditions.

The FPC identifies risks to financial stability and agrees on policies aimed at safeguarding the resilience of the British financial system. In its latest report, the committee said that the British banking system is reliable and can continue supporting households and businesses.

The review said that financial stability has remain unchanged since June. However, the global geopolitical developments and state of economies remains heightened, it added.

This is amid the escalation of the conflict in Middle East, following Iran’s attack on Israel on Tuesday. Elevated geopolitical risks, as well as changes in demographics and climate, can increase the pressure on major economies. This could lead to greater national debt and higher interest rate levels.

The FPC reported a “short-lived spike in volatility and falls in equity indices across global financial markets,” recorded in early August. The spike was prompted by weaker than expected U.S. jobs data and results for artificial intelligence tech companies in the United States.

Additionally, shifting interest rate differences between the Untied States and Japan contributed to a surge in volatility. However, owing to positive macroeconomic news that followed, the majority of asset prices quickly returned to, or close to, their initial levels.

Businesses and financial institutions need to be “prepared” for “severe but plausible stresses,” the FPC warned.

“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,” the report said.

Improving Outlook

The FPC has recorded a continuously improving economic outlook in the UK since its last meeting at the end of June. It noted a slightly stronger GDP and a slightly lower rate of inflation.

August saw the BoE slash the cost of borrowing from 5.35 to 5 percent, in a first interest rate cut in more than four years. The path for the expected interest rate, which acts as an anchor for mortgages, fell by around 75 basis points compared to the second quarter of this year.

The FPC said that while some lower-income households and renters remained under pressure, the general picture for mortgagors was that of resilience to higher interest rates.

About a third of mortgage-holders have not yet refinanced onto higher interest rates. The report also noted that the proportion of people spending more than 70 percent of their income on mortgage payments was expected to remain broadly flat.

UK businesses were found to be resilient to high interest rates, and the corporate debt vulnerability was recorded at significantly below its pandemic peaks. Insolvencies were recorded mostly among very small businesses and were linked to a relatively small proportion of bank debt.

“Firms in more vulnerable sectors such as construction, wholesale and retail trade, and accommodation and food service activities made up around half of cases,” the report found.

But even if economic and financial conditions were to be substantially worse than expected, the UK banking system would be able to support households and businesses, the FPC said.

Commenting on the risks to the economy from artificial intelligence, the committee said that AI could both benefit the markets and amplify existing risks.

The FPC said it will continue monitoring systemic risks posed by AI.

“Developing an effective monitoring framework to understand the most material changes in the use and risks from AI was necessary in order to judge how well captured these risks were in existing regulatory approaches,” the report said.