LONDON (AFX) - Current imbalances in the UK economy could become a risk to financial stability if they persist, according to the Bank of England.
In its latest Financial Stability Review, the bank said the imbalances arise from the differing fortunes of the manufacturing and services sectors.
Sterling's strength and weakening global demand have led the net rate of return on capital in the manufacturing sector to levels last seen at the bottom of the business cycle in 1991. In contrast, the services sector has been strong amid a backdrop of firm domestic demand, it said.
But strong domestic demand also poses problems, BoE added. "In an environment where output and income growth are expected to slow and where domestic demand will itself eventually need to slow, the longer robust household spending persists - especially if accompanied by continuing high rates of borrowing - the greater the risk of a difficult adjustment," it said.
Rising levels of indebtedness makes the household sector more vulnerable if there is a downturn in asset prices, a slowdown in the growth of disposable income or even a rise in interest rates, BoE added.
Turning to the UK banking system, BoE said developments both global and domestic have yet to lead to a deterioration in asset quality. Looking ahead however, the picture is less rosy. The risk on exposures to some emerging market economies, namely Turkey, Indonesia, Argentina and Brazil has increased since December, it said. Within the UK, lending to the commercial property sector has risen sharply as has unsecured consumer credit, necessitating higher provisions in some banks.
On balance, however, the UK banking system as a whole appears well placed to accommodate increased credit risk, it said. Overall, financial systems in the UK, Europe and the U.S. appear generally robust, BoE said.
"Published data in most countries paint a picture of banking systems both profitable and well capitalised. But the operating environment may now become more difficult than appeared likely six months ago, especially if the slowdown in world activity turns out to be longer or deeper than currently expected in markets," BoE said. Commenting on the bank's assessment, David Clementi, Deputy governor for financial stability, said the U.S. slowdown and the global correction in telecom and technology shares have been akin to a 'natural stress test' for the international financial system.
" So far it has proved resilient. The environment may, however, now become more difficult than six months ago, especially if the slowdown in world activity were to turn out to be longer or deeper than currently expected," Clementi said.