LONDON – Valuations in artificial intelligence remain vulnerable to a “sharper correction” than experienced in July, the Bank of England (BOE) warned, noting the widespread implications of such a crash for global growth and sovereign bond yields.
In its quarterly financial stability record, BOE policymakers said interconnected vulnerabilities in the financial system were rising, with an increased chance of multiple risks crystalising at once.
The multi-trillion dollar AI market is a key contributor to risks, as is the “re-escalation of the conflict in the Middle East”, which the BOE sees as leading to a “more protracted negative supply shock to the global economy”, and in turn higher sovereign bond risks.
The central bank has repeatedly warned on potential asset bubbles building in areas including AI-related stocks, credit markets and sovereign debt.
Since its last review, AI stocks have swung wildly amid fears of a possible slowdown in development. Equities have also been more volatile across the board, prompting companies including smart ring maker Oura to delay their initial public offerings.
The BOE said that July’s AI shock was amplified by “an unwinding of stretched positions and associated deleveraging activity” but stressed that there was “no spillover to core markets”.
Growth prospects for economies are now linked in part to expectations that AI will boost productivity, and “a reassessment of those expectations could therefore affect not only AI-related asset valuations but also sovereign debt markets”.
In a Bank Insights article published in the morning on Sept 30, BOE governor Andrew Bailey noted that AI has “important implications” for financial stability and stressed the importance of “rigorously testing” AI capabilities and features to minimise the risk of cyber threats.
“Over time, a more formal regulatory framework may well emerge,” he wrote. “But regulation is not, in my view, the right place to start. Understanding, testing and establishing credible points of intervention must come first.”
In its twice-yearly systemic risk survey also published on Sept 30, the BOE said a record number of participants cited risks around AI.
The BOE’s Financial Policy Committee noted that risky credit markets, including some parts of private credit, remain “vulnerable to a tightening in financing conditions”, and that risk taking in some areas remains “elevated”.
Despite concerns about leverage in the markets more broadly, the BOE confirmed that further analysis supported its July proposals to relax an absolute cap on banks’ leverage.
The BOE concluded that risks from gilt market leverage could be better managed through planned gilt market reforms, which the central bank will consult on in early 2027, rather than through the leverage ratio which governs banks’ balance sheets.
It said, however, that policymakers would keep the matter under review and could increase banks’ leverage ratio buffers by 25 basis points should be risks shift.
Gilt yields jumped in recent months in line with global government bond markets, as elevated energy prices fan fears that central banks will have to raise interest rates further to combat inflation.
These “persistently higher sovereign yields could contribute to tighter financing conditions for households and business and increased market volatility”, the BOE said.
Officials added that hedge fund leverage in the gilt market has remained elevated.
The BOE has held rates since officials gave their last financial stability assessment. Swaps markets are pricing in as many as five increases by the end of 2027, starting in November.
Financial stability officials reiterated their stance that households remain resilient to rising debt costs, while banks are well capitalised to withstand potential shocks. BLOOMBERG
