The Bank of England has warned the value of shares and other assets could fall sharply if financial markets are underestimating the risks of a fresh crisis.
Dave Ramsden, the Bank’s deputy governor responsible for banks and markets, said there was a disconnect between heightened levels of global policy uncertainty and the relatively relaxed attitude of investors.
Speaking at the Inverness Chamber of Commerce in Scotland, the Threadneedle Street official said a key measure of investor nervousness – the Vix index – had been relatively stable despite the threats posed by slowing growth, a trade war and Brexit.
Ramsden added that there might be good reason why markets were optimistic about being able to ride out any difficulties, but said the experience of the financial crisis of 2007-9 showed economies were not always as resilient as they appeared.
“This apparent disconnect does not necessarily mean that markets are complacent – the policy uncertainty index might be more sensitive to short-term political developments, while market indices could also be factoring in a belief that monetary policy might be able to offset the impact of shocks,” he said.
“But if market participants are underestimating the extent of political risks materialising, that suggests the potential for sharp price corrections if those shocks do come about.”
Ramsden said the policy environment could prove challenging, citing a disruptive no-deal Brexit as “unarguably” the biggest risk for the UK economy. He added that there were three lessons to be drawn from the financial crisis, which began shortly after he became chief economist at the Treasury.
The first lesson, Ramsden said, was that the past was not always a good guide to the future. The second was that the UK appeared to be resilient but was actually one of the more vulnerable countries to a financial shock. Thirdly, policymakers had to be ready to cope with the unexpected.
The UK economy had proved more resilient to the result of the EU referendum than the Bank had expected, Ramsden said.
“This resilience is good news, and has been positive for households and businesses. But as policymakers, it is important that we look at the underpinnings of this resilience,” he said.
“GDP growth since the Brexit referendum has mainly been supported by continued consumption growth, even despite the hit to real household income caused by the fall in sterling around the referendum. Consumption has instead been funded, perhaps less sustainably, by a historically low household saving ratio.
“The weakness of investment also casts further doubt on how durable the resilience of the labour market has been. Usually, business investment and employment rise and fall together – in aggregate, businesses either increase hiring and investment at the same time, or they cut them both.
“For businesses to be increasing employment at the same time that they are reducing investment suggests something unusual is going on.”