The Bank of England said on Wednesday that the Iran war had dealt “a substantial negative supply shock” to the world economy, increasing the danger that pre-existing threats to financial stability materialize.
The BoE said the prospect of weaker growth and higher inflation and borrowing costs raised the chance of risks crystallizing simultaneously in government debt markets, private credit and the valuations of U.S. tech giants.
“The conflict has made the global environment materially more unpredictable and followed a period in which global risks were already elevated. This increases the possibility of large, frequent and potentially overlapping shocks and periods of intense volatility,” the BoE’s Financial Policy Committee said in a quarterly update.
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The BoE said market contacts expected the conflict to be “short-lived,” but noted high-levels of uncertainty over its trajectory and long-term impacts.
Iran Conflict Pushes Up Inflation, Financing Costs
The U.S. and Israel launched coordinated strikes against Iran on February 28. Since then, Iran has prevented most ships from passing through the Strait of Hormuz, the conduit for around a fifth of global oil and liquefied natural gas supplies, causing UK natural gas prices to increase by more than 70%.
Petrol prices have risen around 10% and household energy bills are set to increase from July when a new regulated price cap comes into effect. Borrowing costs have also risen, with two-year mortgages around 90 basis points higher than before the war, while 21% of available residential mortgage products have been withdrawn.
The BoE said Britain’s government debt market – which has seen some its biggest intra-day swings in years and the highest 10-year borrowing costs since 2008 – was vulnerable to the concentrated positions taken by some hedge funds.
“These cross-market positions, in addition to firms pursuing similar strategies, increased the risk of disorderly unwinds causing jumps to illiquidity in core UK markets, including through cross-border spillovers,” the BoE said.
Big share price falls could also lead to some investment firms selling gilts, it added.
AI Valuations ‘Particularly Stretched’
Valuations of big U.S. tech companies that have invested heavily in artificial intelligence had already looked stretched last year and now looked particularly so as their data centers were hit by higher energy costs and supply-chain disruption caused by the Iran war, the BoE said.
The default of British specialist mortgage lender Market Financial Solutions in February also highlighted weaknesses in risky private credit markets, the BoE said.
Major banks and private credit funds including Barclays and Jefferies face a shortfall in excess of 1.3 billion pounds.
Overall, however, Britain’s households, businesses and banks remained strong, with indebtedness generally low by historic standards, the central bank said.
If market expectations for higher interest rates materialize, 58% of mortgage borrowers were likely to face higher repayments by the end of 2028, it added.
While increases were likely to be moderate, especially in comparison to previous rises in recent years, sustained increases in mortgage rates and energy prices would put renewed pressure on household finances, the BoE said.
(Reporting by David Milliken and Phoebe Seers)
