The Bank of England has issued a stark warning that the UK could face a credit crunch, as financial markets remain vulnerable to a “sharp correction.” Policymakers cautioned that a sudden crash in global markets could significantly raise borrowing costs for both households and businesses in the UK.

The Financial Policy Committee (FPC), chaired by governor Andrew Bailey, flagged several global risks, including concerns about economic growth, escalating tensions in the Middle East, and substantial bets against US bonds ahead of the November elections. These factors contribute to a precarious environment for global markets.

The FPC highlighted that while interest rates have started to fall, potentially easing the burden on 3 million UK households yet to refinance onto more expensive fixed-rate mortgage deals, markets remain volatile. Share price valuations were described as “stretched,” and the committee warned that a market correction could reduce the availability of credit.

Geopolitical risks, particularly the recent conflict between Israel and Iran, have driven oil prices higher and weighed on US stock markets. The Bank’s systemic risk survey revealed that finance executives consider geopolitical instability to be their top concern, ahead of cyber attacks and a slowdown in the UK economy.

However, the Bank noted some relief for mortgage holders. Around 1.7 million borrowers have already benefited from a reduction in the Bank’s base rate to 5%, with borrowing costs falling. An additional 3 million borrowers are due to refinance by 2027, with those refinancing over the next year expected to see a smaller rise in monthly payments than previously forecast.

In addition to the UK market risks, the Bank expressed concern over rising hedge fund bets against US Treasuries, which have surged to more than $1 trillion. The FPC warned that an unwinding of these trades could exacerbate future market stresses.

The fragility of financial markets was highlighted by the share sell-off in August, triggered by weaker-than-expected US jobs data and the end of Japan’s era of cheap borrowing. While the volatility was short-lived, it exposed significant global vulnerabilities and a disconnect between share valuations and growth concerns.

The Bank urged financial institutions to prepare for severe market shocks and acknowledged that the current economic environment remains highly uncertain, with markets remaining susceptible to sudden downturns.