Bank of England: 'Prepare for economic storm'

By: Frank Knopers

The Bank of England is warning the banking sector to prepare for economic downturn and advising banks to strengthen their capital buffers. The central bank speaks in its Latest Report on the financial stability of a Member State 'Substantial deterioration in the economic outlook'. Not only in the UK, but also in the rest of the world.

Of course, high inflation is a source of concern for the central bank. The unprecedented rise in energy prices has made households and businesses more vulnerable. This can also have consequences for banks' loan portfolios, such as an increase in the number of bankruptcies and a fall in house prices. Especially now that interest rates have risen further.

The Bank of England writes in its report that the banking sector is well positioned to weather an economic downturn. Nevertheless, she advises banks to double the counter-cyclical capital buffers to 2% within a year. The central bank can adjust this buffer if the outlook for the economy and the banking sector change.

Liquidity remains an issue

Double-digit inflation isn't the only thing the Bank of England is worried about. In the stability report, the central bank also warns of deteriorating liquidity in the government bond market. Government bonds are traditionally a safe haven, as this market is normally highly liquid. A liquid market is when it is easy to buy and sell large volumes without this having much effect on the price.

The central bank has also seen a change in this market since the corona crisis: "With high volatility, liquidity deteriorates even in markets that are normally the most liquid, such as the market for U.S. Treasuries, U.K. Treasuries and interest rate futures." According to the central bank, it has become more expensive to trade government bonds. For example, the difference between the buying and selling rate is now more than twice as large as a year ago. "These conditions could deteriorate further, especially when volatility increases."

Government bonds are essential for the proper functioning of financial markets. This is because they are used on the financial markets as collateral for new loans. Problems in the bond market can therefore also disrupt bank lending to households and businesses. With all the consequences that this entails for the economy.

This contribution comes from Geotrendlines

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