Bank of England warns Middle East conflict threatens financial stability with potential
The Iran war threatens to increase instability in the financial system after delivering a ‘substantial’ shock to the global economy, the Bank of England has warned.
The central bank said the war had followed a period in which risks to stability had already increased, including in private credit markets.
It also warns mortgage payments for 5.2million borrowers – or three in five households – are likely to increase between now and the end of 2028.
Since the start of the war, markets have moved significantly in response to rising oil prices, with government yields surging and some widening of credit spreads.
The Bank of England warned that the war is likely to weigh on growth, drive up inflation and lead to tighter financing conditions.
It said these conditions raise the chances of these risks crystallising simultaneously in private credit and bond markets.
‘The conflict has made the global environment materially more unpredictable and followed a period in which global risks were already elevated,’ the central bank said in a quarterly update.
‘This increases the possibility of large, frequent and potentially overlapping shocks and periods of intense volatility.’
‘Intense volatility’: The Bank of England said the war threatens financial stability
It added: ‘Heightened uncertainty and unpredictability have made it harder for markets to price underlying economic fundamentals, increasing the likelihood and magnitude of sharp market shifts in response to new information.’
The Iran war has triggered significant volatility in global markets, as investors price in the impact of an energy supply shock.
The Bank pointed to a worsening outlook for global bond markets, which has the potential to weigh on growth, raise interest rates, and increase spending pressures.
In particular, the British government bond market – which has soon huge intra-day swings and the highest 10-year borrowing costs since 2008 – was vulnerable to concentrated positions taken by some hedge funds.
‘These cross-market positions, in addition to firms pursuing similar strategies, increased the risk of disorderly unwinds causing jumps to illiquidity in core UK markets, including through cross-border spillovers.’
The Bank of England also warned that any increase in interest rates could have a knock-on effect on private credit, where investor sentiment ‘had worsened before the conflict started,’ the BoE said.
Private credit funds have been hit by a wave of redemption requests driven by AI concerns and rising defaults, with some firms halting withdrawals entirely.
While markets have pared back their expectations for interest rate hikes this year, after President Trump signified the war could end soon, they are still pricing in at least one 25-point increase by the end of the year in the UK.
The BoE also said that the valuations of US tech giants that had invested heavily in artificial intelligence looked stretched.
‘The conflict could increase these concerns, particularly given the energy-intensive nature of the supply chain for key components and the operation of data centres,’ it said.
In the UK, the outlook had ‘deteriorated’ with SMEs and highly leveraged corporates most vulnerable to supply shocks, but businesses overall were resilient despite the ‘challenging’ conditions.
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