The soaring valuations of American technology companies risk fuelling an artificial intelligence bubble that could burst and cause a global market sell-off that would hit the UK, the Bank of England has warned.
Stock market valuations, particularly in the United States, “appeared stretched” and on some measures in the US are “comparable to the peak of the dotcom bubble”, officials on the Bank’s financial policy committee said.
The surging share prices of the biggest American tech companies have resulted in US share indices becoming increasingly concentrated around these stocks, leaving “equity markets particularly exposed should expectations around the impact of AI become less optimistic”.
It is the strongest warning yet from the Bank about the threat that the investor frenzy for AI might pose to markets. Excitement about the technology’s potential has grown significantly ever since the American group OpenAI caused a sensation with the release of its ChatGPT bot in late 2022.
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Tech companies, including the listed giants Microsoft and Meta, are planning to spend hundreds of billions of dollars on developing the technology, including by building the data centres and other infrastructure that are the foundations of the AI ecosystem. However, even some of AI’s leading proponents have signalled that the industry is in bubble territory. Sam Altman, the boss of OpenAI, said recently that investors were “over-excited” about AI.
Lofty valuations in the tech sector were one of a number of risks highlighted by the Bank in the record of the latest meeting of its financial policy committee, which includes Andrew Bailey, its governor.
Overall, the committee judged that “the risk of a sharp market correction had increased”, adding: “A crystallisation of such global risks could have a material impact on the UK as an open economy and global financial centre”.
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Other worries flagged by officials included concerns that the independence of the US Federal Reserve, which has come under attack by President Trump, could be undermined, and rising public debts in economies around the world. However, they concluded that British households and businesses “remained resilient” and that the UK banking system could support the economy in the event of a crunch.
How worried should we be?
With stock market indices from the S&P 500 in the United States and the Nikkei 225 in Japan to the FTSE 100 in Britain trading at or near record highs, it is little wonder that some investors believe a big sell-off is on the horizon.
They will have found more worries to keep them up at night in the latest quarterly update from the Bank of England’s financial policy committee, in which officials warned that everything from the threat of a bubble in AI to concerns about the independence of the US Federal Reserve meant “the risk of a sharp market correction had increased”.
A new tech bubble?
One of the main market risks identified by the Bank were the rocketing valuations of America’s biggest technology companies amid rising hype about the potential of AI.
“Equity valuations appeared stretched, particularly in backward-looking metrics in the US,” officials said, adding that on some measures they were “comparable to the peak of the dotcom bubble”.
The soaring share prices of the largest tech companies have lifted their concentration within American stock market indices to record levels, such that “the market share of the top five members of the S&P 500, at close to 30 per cent, was higher than at any point in the past 50 years”.
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As a result, the committee warned that “any AI-led price adjustment would have a high level of pass-through into the returns for investors exposed to the aggregate index”.
While the committee conceded that there were “upside risks” to valuations, it focused on the potential downsides. These included “disappointing” progress on AI capabilities and adoption.
“Material bottlenecks to AI progress –— from power, data, or commodity supply chains — as well as conceptual breakthroughs, which change the anticipated AI infrastructure requirements for the development and utilisation of powerful AI models could also harm valuations, including for companies whose revenue expectations are derived from high levels of anticipated AI infrastructure investment.”
Fed independence
President Trump has intensified his attacks on the American central bank in recent months, raising concerns among investors about the risk of political influence on the Fed.
While the Bank did not mention Trump by name, it noted “continued commentary about Federal Reserve independence”.
“Central bank operational independence underpins monetary and financial stability — and therefore lowers borrowing costs for households and businesses,” the committee said.
President Trump tried to fire Lisa Cook, a member of the Federal Reserve board of governors
SAUL LOEB,ANDREW CABALLERO-REYNOLDS/AFP/GETTY IMAGES
“A sudden or significant change in perceptions of Federal Reserve credibility could result in a sharp re-pricing of US dollar assets, including in US sovereign debt markets, with the potential for increased volatility, risk premia, and global spillovers.”
This may have a knock-on effect on interest rates in other countries, the officials warned.
“The consequences for other sovereign borrowing costs, which had tended to be correlated with US interest rates, would be a key uncertainty in such a scenario.”
Public debts and political turmoil
Rising public borrowing is a problem around the world and political divisions about how to tackle these debt burdens are causing chaos in France, where Sébastien Lecornu this week became the third prime minister to leave office since late last year. In Japan, high public debt is also a source of political tension.
The Bank noted that “world and advanced economies gross debt to GDP ratios increased to 92.3 per cent and 108.5 per cent, respectively, in 2024 and were forecast to increase each year to 2030 — peaking at 99.6 per cent and 113.3 per cent”.
The committee cited “political deadlocks in France and Japan” as examples of “political uncertainty over the level and pace of reforms to improve the fiscal outlook”.
Sébastien Lecornu resigned as prime minister of France this week, a setback for President Macron
LUDOVIC MARIN/AFP/GETTY IMAGES
“These challenges had been reflected in sovereign debt yields,” they cautioned, adding that “there were a number of risk channels through which pressures on sovereign debt globally could affect financial stability, including in the UK via cross-border spillovers”.
“These channels included: higher interest rates leading to tighter global financial conditions; increased market volatility interacting with vulnerabilities in market-based finance; the reduced ability of governments to respond to future shocks; and the potential for capital outflows from overseas investors.”
American car crashes
Strains are emerging in the US auto sector after First Brands, an American car parts maker, and Tricolor, a subprime auto lender, collapsed into bankruptcy last month. Both companies had deep ties to the credit markets and their implosions have left some in the City wondering whether they are a canary in the coal mine for this area of the financial system, which has grown rapidly in recent years.
The Bank said these were “notable credit defaults” and that the two companies had shared similar problems, which highlighted risks the committee had previously flagged.
“While operating different business models, their financing appeared to display several common factors including high leverage, weak underwriting standards, opacity, complex structures, and the degree of reliance on credit rating agencies, illustrating how corporate defaults could impact bank resilience and credit markets simultaneously.”
Silver lining
Despite mounting risks, the Bank said it believed households and corporates in Britain “remained resilient”. The committee “maintains its judgment that the UK banking system has the capacity to support households and businesses even if economic and financial conditions were to be substantially worse than expected”.