• The Bank of England warns that the global economy is facing a substantial negative supply shock linked to the Middle East war.
• The Financial Policy Committee says the financial system remains resilient but highlights rising vulnerabilities across debt and credit markets.
• Elevated valuations in risky assets, particularly US technology stocks, are identified as a potential source of systemic stress.

In its Financial Policy Committee (FPC) statement released on Wednesday and reported by Reuters, the Bank of England (BoE) said the United Kingdom’s (UK) financial system remains resilient but warned that global risks are increasing as geopolitical tensions and stretched asset valuations raise the likelihood of financial stress. The central bank stressed that vulnerabilities across sovereign debt markets, private credit and risky asset valuations could crystallize simultaneously and amplify market instability.

The BoE also highlighted the impact of the Middle East conflict, which it described as a “substantial negative supply shock” for the global economy. While markets appear to expect the conflict to be short-lived, policymakers warned that uncertainty around its trajectory and long-term economic consequences remains high. Despite these risks, the BoE said the UK banking system has sufficient capacity to continue supporting households and businesses even if economic conditions deteriorate significantly.

Key takeaways

Financial system resilient so far, but increased risk multiple vulnerabilities crystallise at once

Middle east conflict has caused "substantial negative supply shock" to world economy

Still sees risks in sovereign debt markets, risky asset valuations, private credit

Gilt repo positions affected by small number of funds pursuing similar strategies across jurisdictions and markets

Shock in foreign debt markets or equity valuations could transmit to UK

LDI pension sector remains resilient following post-2022 reforms

Default of Market Financial Solutions (MFS) highlights weaknesses of risky credit markets

US tech company valuations "remain particularly stretched", Iran conflict increases risk as AI data centres and supply chains energy intensive

UK banking system has capacity to support households and businesses even if economic and financial conditions much worse

Market expects Mideast conflict to be short-lived; high levels of uncertainty over trajectory, long-term impact

Based on current market rate expectations, 58% of UK mortgage holders face repayment increases by Q4 2028, mostly modest

UK banks' counter-cyclical capital buffer held at 2%

Market reaction

The report had little immediate impact on the Pound Sterling (GBP), with the GBP/USD pair rising by 0.53% on Wednesday to trade around 1.3300 at the time of writing.