Bank of England and IMF Warn of Market Shock if AI Hype Fizzles

Fears of an AI bubble bursting could trigger sharp corrections in global markets, with tech-heavy US indices most at risk

Rising Concerns Over AI-Driven Market Rally

The Bank of England (BoE) has issued a stark warning that global financial markets could face a “sharp correction” if investor sentiment around artificial intelligence (AI) turns negative. The alert forms part of the Bank’s latest Financial Stability Report, which also highlights broader risks tied to the independence of the US Federal Reserve and mounting political instability.

The BoE’s Financial Policy Committee (FPC) noted that while optimism surrounding AI has fuelled much of the recent stock market rally—particularly in the US—this sentiment may not be sustainable.

• AI-driven gains now account for around 30% of the total valuation of the S&P 500.
• Valuations based on past earnings are now as stretched as they were during the dotcom bubble of the early 2000s.

Kristalina Georgieva, Managing Director of the International Monetary Fund (IMF), echoed these concerns. She stated that investor expectations had reached levels reminiscent of the internet boom 25 years ago, warning of "vulnerabilities" that could impact global growth if valuations retreat sharply.

What’s Driving the Bubble Fears?

Multiple signals suggest that investors are preparing for a potential downturn:

• The spot gold price surged past $4,000/oz for the first time, indicating a shift towards safer assets.
• The AI rally has been heavily concentrated, with just five tech companies dominating the US market.
• A Massachusetts Institute of Technology study revealed that 95% of firms implementing AI had yet to realise tangible returns, raising doubts about long-term profitability.

Additionally, investors have grown uneasy about developments in US monetary policy, as political interference threatens the independence of the Federal Reserve.

• President Trump has reportedly tried to place allies in the Fed and is attempting to remove key members like Lisa Cook.
• Market players fear these moves could lead to unpredictable rate decisions, driving volatility in bond and currency markets.

UK Investors and Budget Implications

For UK investors, the situation poses both domestic and global risks. The BoE warned of potential “spillovers” into British markets, especially due to the strong correlation between UK gilt yields and US Treasury yields.

With borrowing costs already near multi-year highs, the threat of a market correction could:

• Complicate budget planning for Chancellor Rachel Reeves ahead of the Autumn Statement.
• Undermine investor confidence in both tech and government bonds.
• Delay or derail interest rate cut expectations in the UK.

Speculation: What Happens if the AI Bubble Pops?

If the AI enthusiasm collapses, markets could see significant valuation resets:

• Tech stocks could drop sharply, dragging down indices like the S&P 500 and Nasdaq.
• Capital may flow into defensive sectors such as utilities, healthcare, and gold.
• UK tech investors could also feel the impact due to exposure to US markets via funds and ETFs.
• Central banks may be forced to intervene to stabilise credit and equity markets.

Key Takeaways for Investors

• Stay diversified: Overexposure to tech stocks increases portfolio risk.
• Watch the Fed: Political moves in the US could undermine confidence and destabilise markets.
• Monitor UK yields: Higher borrowing costs could affect everything from mortgage rates to corporate investment.

As the AI story unfolds, cautious optimism is warranted. While the transformative potential of AI remains high, the market's expectations may have run ahead of the reality—setting the stage for a correction that could reshape portfolios and policymaking globally.

Sources: (BBC.co.uk, SkyMoney.com)