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Markets could face sharp correction, Bank of England warns

·2-min read
Canary Wharf business district in London

By Huw Jones

LONDON (Reuters) -Stock and bond markets could correct sharply if investors reassess the prospects for the economy's recovery from COVID-19 and there are signs of increased risk-taking at investment banks, the Bank of England said on Friday.

The BoE's Financial Policy Committee (FPC) said in a statement after its October meeting that there was still evidence of elevated risk-taking in a number of financial markets such as shares, bonds and leveraged loans, relative to historic levels.

Stock indexes have hit record highs in recent months as investors bet on a strong recovery after the pandemic, but more recently inflation has become a worry and growth has become patchier in the face of supply side bottlenecks.

Households in Britain and beyond are facing an additional squeeze on their spending power from a surge in energy prices at a time when government support, introduced to households and business when the pandemic began, is being phased out.

"Asset valuations could correct sharply if, for example, market participants re‐evaluate the prospects for growth, inflation or interest rates," the statement said.

"There are signs of continued loosening in underwriting standards and increased risk-taking in some investment banking businesses."

Routine supervision and regular stress testing are being used to monitor the risk-taking, but banks remain resilient, paying out 2.3 billion pounds in dividends in the first half of this year, it added.

The FPC noted uncertainty over how Evergrande Group, one of China's biggest property developers, can meet its financial obligations.

"A disorderly failure could pose risks to the wider property sector in China with potential spillovers internationally," it said. But this year's stress tests by the BoE of banks had shown UK lenders would cope with a severe downturn in China and Hong Kong and sharp adjustments in global asset prices, it added.

While growth in house prices had reached levels last seen before the financial crisis over a decade ago, there was little evidence of a decline in lending standards, the FPC said.

Debt servicing remained affordable for most businesses, it added.

(Reporting by Huw Jones Editing by William Schomberg and Chizu Nomiyama)

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