Bank of England warns of risks from trade war

A looming trade war, rising geopolitical instability and mounting government debt burdens have pushed up the risks facing the financial system, the Bank of England has warned.
Policymakers warned in their latest assessment of possible threats that the UK was particularly vulnerable to a crunch because of its status as an “open economy with a large financial sector”.
They said that markets had absorbed the fallout from both the Labour government’s first budget last month and Donald Trump’s victory in the US election in an “orderly way”.
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They said, however, that already-stretched valuations of some assets had increased further, leaving markets susceptible to a “sharp correction”.
The worsening conflicts in Ukraine and the Middle East, as well as the deteriorating relationship between the US and China, were cited as threats by the Bank. This is because they could cause disruption to international supply chains and drive an increase in cyberattacks against banks and other institutions.
Risks to trade, amid threats from Trump to put high tariffs on China and other countries, were also highlighted by the regulators. “Global fragmentation, namely a reduction in the degree of international trade and policy co-operation, could have several consequences,” they said.
“For the macroeconomy, it could weigh on growth and increase the uncertainty of economic outcomes including around inflation, which could in turn feed into volatility in financial markets.
“The financial system could also be directly affected via disruptions to cross-border capital flows and the reduced ability to diversify risk across borders.”
The Bank added that “high public debt levels in major economies could interact with other vulnerabilities and have consequences for UK financial stability”.
Separately, the Bank released the results of its latest annual stress test on Britain’s biggest banks, which showed that they could all withstand the impact of a sharp economic downturn. This test was introduced in the years following the 2007-09 financial crisis and has typically been conducted annually.
The Bank said, however, that it would move to carrying out the test every other year in future. In the intervening years it may conduct other more exploratory tests on lenders that assess their resilience to different types of risks such as climate change.
The results of a ground-breaking new stress test that assessed the impact of a market crash across the financial system, from banks and insurers to hedge funds and pension funds, were also published by the Bank.
This exercise is the first of its kind by any regulator in the world and the Bank said it had highlighted a number of possible risks, including the threat that sterling-denominated corporate bond markets, a key source of funding for British companies, could temporarily freeze over in a crisis.
It warned that this market “could face a ‘jump to illiquidity’ in stress, whereby the speed of selling pressures significantly exceeds purchasing capacity and prices need to fall rapidly for the market to clear”.