The Bank of England has warned that rising inflation could trigger a sell-off in global financial markets, with damaging consequences for the UK economy.
Against a backdrop of soaring energy prices and severe shortages of workers and materials, Threadneedle Street said inflationary pressures were rising as the pace of economic recovery from the pandemic slows.
In its regular financial health check, the Bank’s financial policy committee said risky asset prices in several markets had risen to historically high levels and could be primed for a sharp fall amid rapid growth in inflation.
“Asset valuations could correct sharply if, for example, market participants re-evaluate the prospects for growth, inflation or interest rates,” the FPC said.
The warning shot comes as supply problems caused by Covid-19 and Brexit drive up business costs at the fastest rate since at least the 1990s, while soaring wholesale gas and electricity prices heap additional pressure on households.
The Bank expects inflation will rise above 4% this winter, the highest level in a decade, and will remain elevated until at least the summer of 2022 before gradually falling back towards its target rate of 2%. However, some analysts have warned inflation could increase at a higher level within months.
Global financial markets have been rattled in recent months amid concerns over inflation as the world economy emerges from lockdown, raising the prospect of major central banks being forced into an early removal of pandemic support measures before the economic recovery from the coronavirus is complete.
Fears have also been raised over high levels of corporate debt, including in China at the embattled property developer Evergrande, where worries over its ability to keep up with debt payments have rippled through global markets.
Although warning that Evergrande could pose “risks to the wider property sector in China with potential spillovers internationally”, Threadneedle Street said the British banking system had been shown in stress tests to be resilient to a severe economic downturn in China and Hong Kong.
Reflecting concern over weaker levels of global economic growth despite rising inflationary pressures, US figures published on Friday showed the world’s largest economy added just 194,000 jobs in September, far fewer than expected.
Economists warned that a sharp sell-off in financial markets could lead to tighter financial conditions, pushing up borrowing costs for businesses and consumers at a delicate moment in the recovery from Covid-19.
The Bank said risky asset prices appeared “elevated relative to historical norms,” reflecting an improved economic outlook compared with the depths of the Covid recession last year, as well as a “search for yield” by investors.
US financial markets have rallied to record highs in recent months, while in London the FTSE 100 is up more than 500 points since the start of the year.