The Bank of England has warned the UK faces growing risks from weaknesses in the global financial system and rising political tensions.
But households and businesses have remained resilient despite cost-of-living pressures.
The Bank’s Financial Policy Committee (FPC) found some risks to financial stability globally have increased since it last had a meeting in December.
The prices of assets such as shares and bonds have risen, leading to higher valuations, even though economic conditions remain challenging.
This means investors may not be putting enough weight on the risk of things getting worse and therefore there is a greater danger that asset prices will drop sharply, which could “ultimately make it more costly and difficult for UK households and businesses to borrow”, the FPC said.
This is already the case in sectors such as commercial real estate, including offices and retail parks, where prices are falling in many countries, particularly in China.
It comes as interest rates have risen across major global economies and could be kept at those levels for longer than expected.
Geopolitical tensions also risk financial stability, namely the ongoing war in Ukraine and conflict in the Middle East.
International shipping in the Red Sea has faced disruption as a result of attacks from Iran-backed Houthi rebels since November, leading to delays as ships are forced to take lengthy detours.
If global tensions worsen, this poses a risk to financial stability in the UK, the Bank warned.
Meanwhile, the committee said the outlook for UK households has slightly improved since the end of last year, even though they remain under pressure from increased living costs and higher interest rates.
Rising wages have helped strengthen household finances, and mortgage rates have come down slightly since December.
Nevertheless, about 45% of fixed-rate mortgage holders are still facing higher monthly repayments when they reprice their mortgage by the end of 2026.
There has also been an ongoing trend towards longer-term mortgages, with about half of all loans issued in the last three months of 2023 given terms of 30 years or longer.
The FPC said this has made the loans more affordable for many borrowers, but it could also affect future borrower and lender resilience if people are more at risk of defaulting on their repayments.
The level of mortgage arrears has increased slightly since the FPC’s last meeting, and is expected to rise further, but remains low by historical standards.
The committee stressed the UK banking sector is strong enough to support households and businesses even if economic conditions get significantly worse.
Elsewhere, the FPC said it is looking deeper into the risks to financial stability posed by the private equity sector, which it said grew rapidly over the past decade when interest rates were relatively low.
With interest rates rising more recently, a reversal of the boom in private equity investment could put some firms in a more vulnerable position.
The Bank said it will provide an update on its review of the sector in June.
