LONDON: Financial markets, which have rebounded recently on low global interest rates and vast economic stimulus during the coronavirus pandemic, could be in for a "sharp" correction, the Bank of England warned on Friday. Investors have increased their exposure to riskier assets such as equities in view of the brighter economic outlook.
But they could be forced to reassess their positions, the BoE's Financial Policy Committee, which is tasked with safeguarding the financial system, warned in a new report. Like other central banks around the world, including the US Federal Reserve, the BoE launched a massive asset-purchasing programme, buying up corporate bonds, that helped to fuel a rally in global markets.
"Following the Covid shock, central banks cut interest rates and undertook asset purchases to support economic activity and prevent an unwarranted tightening of financial conditions for corporates and households," the FPC's financial stability report said.
"Since then, risky asset prices have increased and, in a number of markets, asset valuations appear elevated relative to historical norms."
Those valuations "could correct sharply if, for example, market participants re-evaluate the prospects for growth, inflation or interest rates," it said.
Markets are on edge over the inflation outlook, as consumer prices soar on the back of economic reopening, supply chain problems, runaway energy costs and other commodity prices.
The FPC pointed to "signs of continued loosening in underwriting standards and increased risk-taking in some investment banking businesses".
And those risks "can affect UK financial stability through the direct impact on banks and the indirect impact of losses spreading through other parts of the global financial system", it said.
However, the FPC said the core UK banking system was "resilient" to such losses. Central banks are now grappling with how and when to withdraw ultra-loose monetary policy and massive stimulus programmes.
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