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BoE’s Bailey expects AI to lift UK growth but warns of bubble risks
The resilience of UK economic activity was highlighted by Bank of England (BoE) Governor Andrew Bailey during a speech at the Swiss Institute of International Studies SIAF in Zurich, Switzerland. He said that “UK economic activity is proving more resilient than expected, partly due to AI investment, particularly in business services.”
While pointing to the potential for AI, digital technology and robotics to boost “sustainable economic growth,” Bailey also warned that the “AI asset price bubble poses clear financial stability risks.”
Bailey Highlights AI’s Growth Potential and Financial Risks:
Partly supported by AI investment, especially in business services, UK economic activity is showing greater resilience than anticipated.
By improving productivity, AI, digital technology and robotics could increase sustainable economic growth.
Evidence is mounting of an emerging positive supply shock linked to AI and investment.
A bubble in AI asset prices presents clear risks to financial stability.
Although AI could deliver strong returns, markets may overestimate their value, or those returns may take longer to materialise than anticipated.
Cyberattack risks have risen with frontier AI, requiring more extensive testing of models both before and after release.
BoE Policy and Sterling Explained
Responsibility for the United Kingdom’s monetary policy rests with the Bank of England (BoE), whose main objective is ‘price stability’: a steady inflation rate of 2%. To pursue that goal, it adjusts base lending rates. By setting the rate at which it lends to commercial banks and banks lend to one another, the BoE determines the overall level of interest rates across the economy. The value of the Pound Sterling (GBP) is also affected.
Inflation above the Bank of England’s target prompts it to increase interest rates, raising borrowing costs for households and businesses. Higher rates support the Pound Sterling by making the UK a more attractive destination for international investors’ funds. By contrast, below-target inflation signals slowing economic growth. In that situation, the BoE will consider cutting rates to make credit cheaper, hoping to encourage businesses to borrow for projects that generate growth. This weighs on the Pound Sterling.
When interest rate cuts cannot deliver the required outcome, the Bank of England may turn to Quantitative Easing (QE) as a last resort in extreme circumstances. This policy substantially expands the flow of credit through a stalled financial system. Under QE, the BoE prints money to purchase assets from banks and other financial institutions, typically government bonds or AAA-rated corporate bonds. A weaker Pound Sterling is the usual result.
As the economy strengthens and inflation begins to rise, Quantitative tightening (QT) reverses the process of QE. Under QE, the Bank of England (BoE) buys government and corporate bonds from financial institutions to encourage lending. Under QT, it instead ceases further bond purchases and no longer reinvests the principal repaid when its existing bond holdings mature. The policy is generally supportive of the Pound Sterling.
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