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Bank of England warns on currency
Monday, December 13, 2004 Posted: 0030 GMT (0830 HKT)
The BoE says the euro area has a less positive economic outlook than elsewhere.
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LONDON, England (Reuters) -- Uncertainty about future foreign exchange moves and what impact they might have on interest rates and asset prices is one possible risk to a stable outlook for the financial system, the Bank of England said on Monday.
The warning in the BoE's twice-yearly Financial Stability Review comes at a time when the dollar, while up from record lows against the euro, remains under pressure on concern that the United States must narrow its gaping trade and budget deficits.
"Globally, doubts about the sustainability of the current pattern of capital flows have increased, with downward pressure on the U.S. dollar and rising uncertainty about future foreign exchange movements -- and about their consequences for interest rates, asset prices and activity," the FSR said.
"That may affect the market risks faced by financial institutions and, over a longer time horizon, the creditworthiness of borrowers in any countries where growth slows sharply."
While strong economic growth around the world has meant few pressures for domestic banking systems to deal with, the report cited the euro area as one with a less positive outlook.
"The picture in the euro area is perhaps less encouraging than elsewhere, given the downward revisions to expectations for GDP growth and concerns about the possible impact of dollar depreciation," it said.
Meanwhile, U.S. Federal Reserve interest rate hikes delivered this year so far have been signalled in an orderly way to markets and there has not been a backup in market interest rates that some had feared, the review said.
The Fed is widely expected to raise rates on Tuesday for a fifth time this year, to 2.25 percent.
The BoE reiterated a concern expressed in its last review six months ago that an aggressive quest for yield may have led some institutions to accumulate positions in assets which are relatively illiquid, or difficult to trade.
"In the present benign environment, there is a possibility that lenders, borrowers and investors may be inclined to underestimate long-run vulnerabilities and take on too much risk," said BoE Deputy Governor for Financial Stability Sir Andrew Large.
"With this in mind, we continue to monitor closely developments in a number of areas, including the search for yield," he said.
Given the difficulty for investors of achieving high yield returns in traditional investments like stocks or bonds, hedge funds, which often stake higher returns on highly leveraged bets in the bond markets, for example, have become more popular.
Industry estimates show that hedge funds worldwide are worth some $1 trillion (£525 billion). That is double the size four years ago and is five times bigger than a decade ago.
The BoE flagged the growth in structured credit products and leveraged loan and high yield debt markets as an example of the ongoing demand by investors for higher returns.
"It is, perhaps, significant that some market contacts have expressed misgivings at the scale of investor demand for risky and potentially illiquid markets," the FSR said.
"Unexpected economic developments could trigger the attempted simultaneous unwinding of common positions, possibly leading to strains on market liquidity."
The BoE also noted that while the level of unsecured debt held by British households is far lower than the secured debt held through mortgages, it has been rising more rapidly.
"Although banks have continued to improve credit-scoring models and stress tests, these techniques have yet to be tested by a period of pronounced economic strain," the review said.
"If, in such a period, lenders attempted to lower risk by making it much more difficult or expensive for borrowers to roll over their unsecured lending, wider repayment problems might be precipitated."
The BoE also noted that lending to the commercial property sector has risen rapidly and that while corporate capital gearing is continuing to ease, it still remains high compared to the standard of the past two decades. |
