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\t\tBank of England governor Andrew Bailey\t<\/p>\n\t\t\tWednesday 03 December 2025 6:32 am\n\t\t\t<\/p>\n
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\t\tBank of England governor Andrew Bailey\t<\/p>\n
The Bank of England has sounded the alarm on international hedge funds snapping up record levels of UK government debt, warning that their highly leveraged bets leave Britain increasingly exposed to a bond market meltdown.<\/p>\n
In its biannual\u00a0Financial Stability Report<\/a>, the central bank said the large share of UK government debt held by risk-seeking asset management firms means the economy is more vulnerable to a sudden sell-off of British bonds \u2013 known as gilts.<\/p>\n The UK government has become more reliant on a small number of little-known hedge funds to buy up its debt, after a shake-up in capital market regulation allowed pension funds and insurance firms to diversify away from the longer term bonds the government relies on selling.<\/p>\n Pension funds and insurers had tended to keep their bond holdings until they matured, and given their risk-averse mandates were not as likely to rack up debt to help fund investing elsewhere. But hedge funds, which largely operate on much shorter time frames, have increasingly taken out enormous bets on small price fluctuations in the UK bond market<\/a>, which they then borrow against and reinvest to boost returns.<\/p>\n Bank of England officials warned the amount of debt taken out against gilts has reached its highest level since the central bank started monitoring the trend in 2017. Hedge funds used their gilt portfolios to borrow some \u00a3100bn of extra cash in November, a pattern of behaviour the Bank said \u201cincrease[s] the risk of sharp moves\u201d in the UK government bond market.<\/p>\n \t\tBank of England explores limiting hedge fund leverage<\/p>\n The leverage has left regulators concerned about the strength of\u00a0the\u00a0bond market\u2019s foundations during a downturn in financial conditions, as the mostly foreign hedge funds would be forced to extricate themselves from the risky trades to pay off debts, compounding a rout. Any sharp sell-off would immediately send government borrowing costs skyward, posing an acute threat to the public finances and a major systemic risk to the financial system.<\/p>\n \u201cForced or widespread deleveraging would have the result of amplifying initial moves and potentially triggering a feedback loop of further forced selling,\u201d the Bank of England\u2019s Financial Regulation Committee wrote<\/a>, \u201cespecially if funding conditions tightened to the extent that refinancing became unavailable or prohibitively expensive.\u201d<\/p>\n Andrew Bailey, the Bank of England governor who chairs the regulation committee, said officials were exploring plans to limit the size of hedge fund bets on gilts in a bid to avoid the worst of any market fallout.<\/p>\n \t\t\t\t\tRead more<\/p>\n \t\t\tBond market braces for gilt and sterling tremors<\/a><\/p>\n Elsewhere in\u00a0Bank\u2019s\u00a0report,\u00a0officials\u00a0highlighted the rapid escalation of debt issuance for artificial intelligence infrastructure, the \u201cmaterially stretched\u201d tech valuations and \u201copaque\u201d shadow banking sector as all raising the likelihood of a market meltdown in 2026.<\/p>\n \u201cRisks to financial stability have increased during 2025,\u201d the Bank\u2019s Financial Policy Committee wrote. \u201cGlobal risks remain elevated and material uncertainty in the global macroeconomic outlook persists.\u201d<\/p>\n Investor speculation over the transformative potential of AI has driven shares in tech firms to historically high valuations through 2025, and meant capital in global stock markets is increasingly concentrated in a few large stocks.<\/p>\n The development has compounded fears that equity markets are \u2018priced to perfection\u2019, meaning they could sell off sharply should AI fail to meet investors\u2019 financial or technological expectations. Bank of England officials warned the spectre of a \u201csharp correction\u201d in equity markets was more likely next year, saying US stock market valuations were the \u201cmost stretched they have been since the dot-com bubble\u201d. UK equities are also enjoying their highest valuations relative to earnings since the global financial crisis.<\/p>\n Private credit and major bond issuance raise concerns<\/p>\n The committee also drew attention to the rapid escalation of riskier lending practices being carried out in corporate debt markets, saying the expansion of AI-related credit posed \u201cfinancial stability risks\u201d.<\/p>\n Much of the initial ramp up in artificial intelligence investment was driven by public and private equity markets. Shareholders were largely happy to fund enormous purchases of AI chips and the data centre projects to allow a company to keep up with intense competition.<\/p>\n Recently, however, many of the AI industry\u2019s largest players have also turned to enormous issuance of corporate bonds and private credit<\/a> \u2013 also known as \u2018shadow banking\u2019 \u2013 to help fund\u00a0their\u00a0expansion, a development Bank officials said posed a greater risk to UK financial stability.<\/p>\n \u201cDeeper links between AI firms and credit markets\u2026 mean that, should an asset price correction occur, losses on lending could increase financial stability risks,\u201d they wrote.<\/p>\n \t\t\t\t\tRead more<\/p>\n