ECONOMY

BOE sees liquidity dangers as Greece threatens market stability

The Bank of England will assess the danger from a shortage of market liquidity as it warned of threats to financial stability from events such as the crisis in Greece.

In a quarterly assessment published Thursday, the BOE’s Financial Policy Committee also said geopolitical tensions, slowing Chinese economic growth and emerging markets also remain a threat to U.K. stability.

“The committee remains concerned that investment allocations and pricing of some securities may presume that asset sales can be performed in an environment of continuous market liquidity,” it said. “Liquidity in some markets may have become more fragile.”

With potential market stresses related to events in Greece and elsewhere, BOE officials have been raising the alarm about low liquidity in recent months. Executive Director Chris Salmon said that structural changes in financial markets may impair liquidity and leave them less able to absorb shocks.

In its analysis, the FPC noted that even small events are rippling through markets. It said trading volumes in some sovereign bonds, including U.S. Treasuries “appear to suggest that sudden changes in market conditions can occur in response to modest news.”

As a result, the FPC called on the BOE and the Financial Conduct Authority, which oversees markets, to jointly assess where vulnerabilities lie and how fund managers and other investors intend to cope with potential shocks. This review, to be completed by September, will see asset managers questioned about their strategies and holdings.

Global Threats

After focusing on the U.K. housing market last year, the FPC has become more concerned about international issues. These potential global risks will form the basis for the BOE’s annual check of banks’ financial strength later this year. The central bank will publish the scenarios for the stress test on Monday.

Among the most pressing issues is Greece, where the government is trying to agree reforms with its creditors to secure emergency aid funds. Alex Brazier, the BOE’s executive director for financial stability, said this month that a failure to find a political solution to Greece’s sovereign debt problem could trigger a market correction.

“A bad outcome in these negotiations could trigger a broader reassessment of risk in financial markets,” he said. “We start from a position where market pricing looks potentially subject to correction.”

[Bloomberg]