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The Bank of England’s Financial Policy Committee said the likelihood of interconnected financial vulnerabilities crystallising has risen since July 2026, citing the re-escalation of the Middle East conflict, sovereign bond yields at levels not seen since 2008, and rapid growth in AI-related debt issuance. The Committee judged the UK financial system and banking sector resilient so far, but warned the risk of a sharp adjustment persists.
The Bank of England’s Financial Policy Committee (FPC) has concluded that the likelihood of interconnected vulnerabilities in the financial system crystallising has risen since its July meeting, according to the record of its 25 September 2026 meeting. The Committee pointed to the re-escalation of the conflict in the Middle East, sovereign bond yields at levels not seen since 2008, and rapidly growing AI-related debt issuance as compounding threats, while judging that the UK financial system has so far remained resilient.
The FPC said the re-escalation of the Middle East conflict has renewed uncertainty around growth and the path of interest rates in several advanced economies, re-intensifying the risk that vulnerabilities in sovereign debt markets, risky asset valuations and risky credit markets crystallise at the same time. Rising oil, gas and refined product prices are producing a more protracted negative supply shock to the global economy, which the Committee said has contributed to sustained increases in sovereign bond yields across a number of advanced economies.
Despite the rise in yields, the Committee found the financial system has been resilient so far and market adjustments have been mostly gradual. It noted, however, that hedge fund leverage in the gilt market, while stable, remains elevated, and that deeper interconnections between vulnerabilities mean the risk of a sharp adjustment persists — underlining the importance of the Bank’s work on gilt repo market resilience.
On artificial intelligence, the record highlights two distinct concerns. First, equity valuations for AI companies fell sharply in July, an adjustment amplified by an unwinding of stretched positions and deleveraging; despite significant losses for some leveraged investors with concentrated positions, there was no spillover to core markets. Second, the volume of AI-related investment financed through debt issuance is growing rapidly, with global AI-related issuance in 2026 expected to exceed that of countries such as the UK. The FPC warned that increasing indebtedness of AI firms, combined with opacity and at times ‘circular arrangements’, can complicate risk assessment and could amplify losses if expectations disappoint.
Why the FPC’s Warning Matters
The FPC is tasked with identifying risks to UK financial stability and agreeing policy actions to protect the resilience of the financial system, so its judgement that the risk outlook has worsened carries weight for lenders, investors and policymakers. The Committee’s framing of interconnected risks — the possibility that sovereign debt stress, asset price corrections and credit market tightening occur simultaneously — signals a more fragile environment than at its previous meeting.
The AI findings also extend the FPC’s attention beyond asset prices to the structure of financing itself. Because growth prospects and fiscal outlooks depend in part on expectations that AI will deliver significant productivity gains, the Committee warned that a reassessment of those expectations could affect not only AI-related valuations but also sovereign debt markets. For UK households and businesses, the Committee judged that both remain resilient and that the UK banking system is appropriately capitalised with high liquidity, strong enough to support them in a stress scenario.
Middle East Conflict and July’s AI Selloff
The record sits against a backdrop of two developments the FPC has tracked this year: the re-escalation of the conflict in the Middle East, which has driven up energy prices and pushed sovereign yields higher, and the July 2026 correction in AI equities. The Committee said concerns about the sustainability of AI-related earnings and capital expenditure growth may have contributed to market sentiment during that selloff, and it judged that the risk of a sharper correction persists, notably if there is a more significant shock to earnings expectations tied to the pace of AI development or adoption.
The FPC also referenced recent frontier AI test-environment incidents, in which autonomous models took unexpected actions, as reinforcing its calls for firms to prepare for AI-related cyber and operational risks. It urged firms to engage with guidance from regulators, the National Cyber Security Centre, and sector groups including the Cross Market Operational Resilience Group, the Frontier AI Information Sharing Forum and the AI Consortium. On credit markets, it flagged the private markets System-Wide Exploratory Scenario (PM SWES) exercise, which is underway to fill data gaps in understanding how private credit might be affected in a stress scenario.
What the Record Leaves Open
The record is a summary of judgements rather than a full set of new policy actions, and several questions remain open. It is not clear how the FPC would respond if elevated hedge fund leverage in the gilt market were to unwind sharply, beyond its stated work on gilt repo market resilience. The Committee itself flagged uncertainty about whether AI-related earnings and capital expenditure growth are sustainable, and whether a larger shock to expectations could trigger a sharper correction than July’s episode.
The scale and opacity of AI-related debt — including the ‘circular arrangements’ the FPC cited — mean the Committee itself acknowledged that assessing risks is complicated. The full conclusions of the PM SWES exercise on private markets have not yet been published, and the published excerpt of the record does not detail all policy actions agreed at the meeting.
Next Steps for the FPC
The FPC will continue its work on gilt repo market resilience and monitor hedge fund leverage in the gilt market. The private markets System-Wide Exploratory Scenario exercise is expected to produce findings that fill data gaps on private credit. The Committee is also expected to press firms to act on AI-related cyber and operational resilience, working through the National Cyber Security Centre and sector engagement groups. The FPC’s next scheduled record, typically published following its subsequent policy meeting, will show whether the interconnected risks it identified have crystallised or eased. Future Bank of England stress tests will continue to test the banking system’s resilience to scenarios including higher energy prices.
Key Questions
What is the Financial Policy Committee?
The FPC is a Bank of England committee that meets to identify risks to financial stability and agree policy actions aimed at safeguarding the resilience of the UK financial system. Its September 2026 meeting was held on 25 September.
Why does the FPC think risks have worsened?
According to the record, the re-escalation of the Middle East conflict has raised energy prices and pushed sovereign bond yields to levels not seen since 2008, while rapid growth in AI-related debt issuance and July’s sharp fall in AI equity valuations have broadened capital market exposure to AI developments. The FPC said these interconnected vulnerabilities are more likely to crystallise at the same time.
Is the UK banking system at risk?
The FPC judged that UK households and corporates remain resilient and the UK banking system is appropriately capitalised with high levels of liquidity. Past stress test results have demonstrated resilience to a scenario with higher energy prices, and the Committee said the system is strong enough to support households and businesses in a stress.
What happened to AI company shares in July 2026?
Equity valuations for AI companies fell sharply in July, with the adjustment amplified by an unwinding of stretched positions and deleveraging. Despite significant losses for some leveraged investors with concentrated positions, the FPC said there was no spillover to core markets — though the risk of a sharper correction persists.
The FPC said AI-related investment is increasingly financed through debt issuance, with 2026 global issuance expected to exceed that of countries such as the UK. It warned that rising AI firm indebtedness, opacity and sometimes ‘circular arrangements’ complicate risk assessment and could amplify losses if expectations for AI-driven productivity gains are reassessed.
Source: primary
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