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Britain's fragile point in a shaky world
Volatile markets and the hedge fund wild card
The Bank of England (BoE) has warned that rising trade barriers are a ticking time bomb for the global economy. The central bank’s latest financial stability report did not hold back, detailing how higher restrictions on international trade are stifling economic growth and creating huge uncertainty about inflation.
It’s a cocktail of risks that is hitting financial markets and borrowing costs are rising for businesses and households alike. The message from Threadneedle Street is: ‘Prepare yourselves.’
But the consequences don’t stop there. The BoE has pointed to a growing breakdown in international financial cooperation that could seriously destabilize the system’s ability to absorb shocks. Translation: If global regulators don’t get their jobs right, future crises could hit much harder than necessary.
Although the BoE did not name names, the timing of this report – just days after President Donald Trump announced his first trade threats – is far from coincidental.
Britain's fragile point in a shaky world
BOE Governor Andrew Bailey, diplomatic as ever, sidestepped questions about the direct impact of Trump’s victory. Instead, he kept his focus broad, saying, “We see the risk of global disintegration increasing. But I can say this: there are a number of reasons for this and I don’t think it’s right to pin it on one particular event.”
Still, the risks to the UK are uniquely worrying. As an economy that thrives on openness and global trade, the UK’s financial system is highly vulnerable to external shocks. The BoE acknowledged that households and banks were in good shape for now, but noted significant vulnerabilities.
The report highlighted that public debt levels around the world, as well as the unpredictable nature of financial markets, were also a major concern. "Uncertainty and risks around the outlook have increased," the BoE said.
Meanwhile, new Chancellor of the Exchequer Rachel Reeves accused the central bank of stifling growth by being too heavy-handed with regulation. Bailey pushed back, saying: “Simply put, there is no trade-off between financial stability and growth. That is a fundamental point.”
But he acknowledged that regulators have some wiggle room in how the rules are implemented. For example: The BoE will now conduct full stress tests on banks every two years instead of annually, a move Bailey said would help make the financial sector more competitive.
Volatile markets and the hedge fund wild card
The report also made no criticism of financial markets, saying they were "vulnerable to a sharp correction". Rising trade barriers, growth risks and inflation tensions are creating a perfect storm. If markets enter a downturn, borrowing costs could skyrocket, hitting UK businesses and households where they are most vulnerable.
And then there are the wild cards: hedge funds and other non-bank financial institutions. These players may seem like big names on paper, but the BoE doesn’t believe it. Hedge funds were warned in the report that they could face a sudden shock that forces emergency sales of assets such as British corporate bonds.
Such a move could create chaos in financial markets and further raise borrowing costs. The BoE is monitoring these risks closely, but the reality is that nonbanks operate outside their traditional purview.
On the brighter side, UK banks are in good shape. They are well capitalised and liquid, passing the BoE’s resilience tests with flying colours. But even here the central bank is relaxing. Starting in 2025, these stress tests will be carried out every two years, freeing up resources to focus on other risks.
In slow years, the BoE will conduct less intensive desk reviews as needed. The central bank is keeping its countercyclical capital buffer steady at 2%.
This so-called “rainy day fund” is designed to help banks weather tough times. But with so many unknowns on the horizon—fracturing global ties, shaky markets and rising public debt—the BoE is clearly keeping its options open.