FPC warns of amplified sovereign debt and private credit risks

The Middle East conflict has created a substantial negative supply shock for the global economy, leading to significant market reactions including volatile energy prices and rising government bond yields.

While the financial system has shown resilience, the shock is expected to weigh on growth, increase inflation, and tighten financial conditions.

This situation is likely to interact with existing vulnerabilities in sovereign debt markets and risky credit, particularly private credit.

The FPC noted that the global environment is now materially more unpredictable, increasing the possibility of large, frequent, and overlapping shocks.

This heightened uncertainty makes it harder for markets to price fundamentals, raising the likelihood of sharp market shifts.

Global sovereign bond markets continue to see historically high issuance, with a higher proportion at shorter maturities.

The conflict worsens the outlook for sovereign debt by potentially raising interest rates and spending pressures, constraining governments' capacity to respond to future shocks.

Risky asset valuations have declined, yet risk premia in global equity and debt markets remain compressed, increasing the potential for sharp corrections.

Valuations for US AI technology companies are particularly stretched, with prior selling pressure due to debt-financing needs.

Investor sentiment in private credit had already worsened, reflecting asset quality, valuation, and liquidity concerns, some linked to AI-disrupted business models.

Domestically, the UK economic outlook deteriorated, but aggregate household and corporate indebtedness remains low, with the FPC maintaining the UK countercyclical capital buffer (CCyB) rate at 2%.

The Committee supports monitoring AI adoption by regulated firms, focusing on agentic AI in payments and financial markets, as risks are likely to increase.