On 5 July 2022, the Bank of England (BoE) published its Financial Policy Committee’s (FPC) latest Financial Stability Report.
The Financial Stability Report sets out the FPC’s view of the outlook for UK financial stability, including its assessment of the resilience of the UK financial system and the main risks to UK financial stability, and the actions it is taking to remove or reduce those risks. It also reports on the activities of the FPC over the reporting period and on the extent to which the FPC’s previous policy actions have succeeded in meeting its objectives.
Key points in the Financial Stability Report include:
- The economic outlook and UK financial stability: The economic outlook for the UK and globally has deteriorated materially, given the Russian invasion of Ukraine, resulting in intensified global inflationary pressures. The outlook is subject to considerable uncertainty and there are a number of downside risks that could adversely affect UK financial stability.
- Financial markets and the resilience of market based finance: Reflecting these developments in the economic outlook, global financial markets have been volatile in recent months. Risky asset prices have fallen markedly since the beginning of the year, and government bond yields have risen. Amid high volatility, liquidity conditions deteriorated even in usually highly liquid markets such as US Treasuries, gilts and interest rate futures. Core UK financial markets have remained functional, with participants able to execute trades, albeit at a higher cost. However, conditions could continue to deteriorate, especially if market volatility increases further. In the event of further shocks, impaired liquidity conditions could be amplified by vulnerabilities in the system of market-based finance previously identified by the FPC.
- UK bank resilience: Aggregate household debt relative to income has remained broadly flat in recent quarters, and there is little evidence of a deterioration in lending standards. However, the rise in living costs and interest rates will put increased pressure on UK household finances in the coming months. Debt-servicing remains affordable for most UK businesses. However, higher interest rates and input prices, weaker economic growth, and continued supply chain disruption are expected to weigh on corporate balance sheets. The FPC continues to judge that major UK banks are resilient to domestic debt vulnerabilities.
- Global debt vulnerabilities: Tighter financial conditions and reduced real incomes will weigh on debt affordability for households, businesses and governments in many countries, increasing the risks from global debt vulnerabilities. These pose risks to UK financial stability through economic and financial spill overs.
- The UK CCyB rate decision: The FPC is increasing the UK countercyclical capital buffer (CCyB) rate to 2%. Given the considerable uncertainty around the outlook, the FPC will continue to monitor the situation closely and stands ready to vary the UK CCyB rate – in either direction – in line with the evolution of economic conditions, underlying vulnerabilities and the overall risk environment.
- The 2022 annual cyclical scenario: To support the FPC’s monitoring and assessment of the resilience of banks to potential downside risks, the BoE will commence its annual cyclical scenario (ACS) stress test in September 2022. It will test the resilience of the UK banking system to deep simultaneous recessions in the UK and global economies, real income stocks, large falls in asset prices and higher global interest rates, as well as a separate stress of misconduct costs.
- Commodity market vulnerabilities: Commodity price volatility following the Russian invasion of Ukraine has further exacerbated price pressures facing households and businesses, and has had implications for the financial system. However, despite the volatility, commodity and wider financial markets have continued to function. Heightened uncertainty following the Russian invasion means there is a significant risk of further disruption in commodity markets. The recent disruption has highlighted how vulnerabilities within commodity markets – and interconnections with the wider financial system – could propagate and amplify macroeconomic shocks.