The Bank of England’s financial policy committee has raised concerns about a potential sharp adjustment of “elevated” bond prices.
In a statement following its meeting this week, the financial policy committee (FPC) argued monetary stimulus and “perceptions of unusually low volatility” had driven a range of fixed income prices to “appear elevated”.
It also warned the UK’s financial stability remained challenging.
“Term and risk premia in bond markets are compressed despite heightened domestic and global uncertainty,” the FPC says.
“This creates a vulnerability to a sharp adjustment that could prove disorderly – for example, if asset price falls triggered fund outflows and dealers were unable or unwilling to hold additional bonds as inventory.”
The FPC argued UK financial stability “remains challenging” following the country’s voted to leave the European Union in June and points to commercial real estate as a particular area of concern.
“The risks of a sharp adjustment are crystallising. Prices have fallen and transactions are at their lowest level since 2009.”
The FPC says, however, that valuations of major UK banks remain “well below their book value”.
It attributed this to concerns about future profitability, including costs to address past misconduct.
But it argues net interest margins of major UK banks have been maintained since the financial crisis and said the Term Funding Scheme, which governor Mark Carney introduced as part of his post-Brexit stimulus package, had reduced wholesale funding costs.
Overall the FPC says risks to UK financial stability remain “elevated” pointing to political and policy uncertainty in “many” advanced economies.
“European bank equity prices reflect continued concerns over banks’ profitability and, particularly in Italy and Portugal, high levels of non-performing loans.”
It raised concerns about the ability of UK households to service debts if the country faces a period of weaker employment and income growth.
“These vulnerable households could affect broader economic activity by cutting back sharply on expenditure in order to service debts.”