By Paul Hannon
Increased borrowing by investors in equity markets has raised the risk of a sharp fall in prices that could threaten the stability of the financial system, the Bank of England warned Tuesday.
In its twice-yearly report, the BOE's Financial Policy Committee said steps towards securing a lasting resolution to the conflict between the U.S. and Iran had helped reduce, but not eliminate, some threats to stability.
"The signing of the Memorandum of Understanding has led energy prices to fall back to just above pre-conflict levels, reducing near-term risks," the BOE said. "However, substantial uncertainty remains and energy prices and interest rate markets have remained volatile."
The FPC said that many of the threats to the system it had previously highlighted have intensified, and noted the increased use of leverage by investors building stakes in AI-related companies.
"There has been a significant rise in hedge fund leverage in equity markets, creating risks, including via the prime brokers that facilitate this activity," the BOE said.
The U.K.'s central bank said the use of leverage could accelerate declines in equity prices should investors encounter a setback, such as disappointing revenues for providers of AI-generated services.
The BOE said hedge funds which also invest in government bonds could face pressure to sell those assets, broadening the impact of the setback.
While a range of setbacks is possible, including a fresh intensification of the U.S.-Iran conflict, the BOE highlighted the risks involved in meeting the historically unprecedented levels of investment needed to develop AI, and high levels of uncertainty about future revenues.
"A reassessment of these prospects could trigger a fall in equity prices that might be amplified by high concentration, correlated momentum-driven positions that can exacerbate volatility as markets fall, and increased leverage," the BOE said.
Write to Paul Hannon at paul.hannon@wsj.com