Bank of England warns stock and bond markets could face sharp correction

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The Bank of England said on Friday that stock and bond markets could quickly correct if investors re-evaluate the economy’s recovery from COVID-19 and signs of increased risk at investment banks.

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The BoE’s Financial Policy Committee (FPC) said in a statement after its October meeting that there was still evidence of high risk-taking in many financial markets such as stocks, bonds and leveraged loans relative to historical levels.

Stock indexes have hit record highs in recent months as investors bet on a strong recovery after the pandemic, but inflation has recently become a concern and supply-side constraints have dented growth .

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Households in the UK and beyond are facing an additional strain on their spending power from rising energy prices, at a time when government aid for homes and businesses is being phased out as the pandemic begins .

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“For example, if market participants re-evaluate the prospects for growth, inflation or interest rates, the valuation of the asset may become increasingly correct,” the statement said.

“There are signs of continued easing of underwriting standards and increased risk-taking in some investment banking businesses.”

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

The FPC noted uncertainty over how Evergrande Group, one of China’s largest property developers, could meet its financial obligations.

“A catastrophic 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 showed that UK lenders will face severe recession in China and Hong Kong and sharp adjustments in global asset prices.

The FPC said the increase in housing prices had reached levels seen before the financial crisis a decade ago, but there was little evidence of a decline in lending standards.

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It said loan service remained affordable for most businesses.

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