Key insights
- The BoE warned of a 'substantial shock' to the global economy due to the Middle East conflict, citing higher energy prices and volatile markets. Oil surged above $100, and UK yields spiked, amplified by hedge fund deleveraging. Mortgage rates rose, and product availability fell. Worsening investor sentiment in private credit and redemption requests in retail funds add to concerns. This could lead to increased inflationary pressure and tighter financial conditions globally, negatively impacting US equities.
Investing.com -- The Bank of England’s Financial Policy Committee warned Wednesday that the conflict in the Middle East has triggered a substantial shock to the global economy, increasing risks to financial stability through higher energy prices and volatile markets.
The conflict between Israel and the United States, and Iran has effectively halted shipping through the Strait of Hormuz and reduced energy production in the Gulf region. Oil prices surged above $100 per barrel, with Brent crude reaching over 60% above pre-conflict levels. European and UK natural gas prices jumped more than 70% higher than pre-conflict levels.
Government bond yields rose sharply in response, with UK 10-year yields increasing 74 basis points and 2-year yields climbing 100 basis points from pre-conflict levels. The moves were amplified by hedge fund deleveraging, predominantly at the short end of the yield curve.
Hedge funds reduced their aggregate net gilt repo borrowing by 21%, or £19 billion, to £74 billion, though this remained elevated by historical standards.
The Committee maintained the UK countercyclical capital buffer rate at 2%, judging that the banking system has capacity to support households and businesses even if conditions deteriorate substantially. UK bank share prices declined in recent weeks but remained significantly higher than a year ago, with the aggregate price to tangible book ratio at 1.4 times.
Average rates for two-year and five-year fixed-rate mortgages rose by an estimated 80 basis points and 70 basis points respectively since the conflict began. The total number of mortgage products available fell from around 8,500 to 7,000.
The Committee noted that investor sentiment relating to private credit had worsened before the conflict started, reflecting concerns around asset quality, valuations and liquidity. Redemption requests were elevated across several international retail funds, with some firms limiting redemptions.
The FPC warned that the global environment is materially more unpredictable as a result of the conflict, increasing the likelihood of large, frequent and potentially overlapping shocks.
The Committee emphasized the importance of timely risk management by market participants, including stress testing that incorporates scenarios with sudden and significant price adjustments.