Bank of England warns of ‘sharp market correction’ if AI bubble bursts

The Bank of England on Wednesday warned that the risk of a “sharp market correction” has increased, noting that valuations appear stretched, particularly for artificial intelligence-focused tech firms. 

The central bank becomes the latest in a long list of banks and investors to weigh in on whether an AI bubble is forming as markets tick into the fourth quarter. 

Heightened geopolitical tensions, fragmented trade and financial markets and pressures on sovereign debt markets play into the risk, the Bank of England said in a record of its latest meeting minutes.

“A crystallisation of such global risks could have a material impact on the UK as an open economy and global financial centre,” it said. 

Equity market valuations stood at near all-time highs, the Bank of England said, thanks in part to strong second-quarter earnings by U.S. tech firms.

“The market share of the top 5 members of the S&P 500, at close to 30%, was higher than at any point in the past 50 years,” it said, noting that AI-focused tech company valuations appear particularly stretched.

“This, when combined with increasing concentration within market indices, leaves equity markets particularly exposed should expectations around the impact of AI become less optimistic,” the meeting minutes said. With such high expectations of future earnings growth, any pullback on AI-related bets could lead to ripple effects, it added.

Investors are closely watching AI-related stocks as earning season gets underway, with some strategists confident that tech company valuations are being driven by sound fundamentals. Goldman Sachs also remained cautiously optimistic in its latest note, believing a bubble has not yet formed but heeded a warning to investors to “diversify.”

Federal Reserve Chair Jerome Powell, however, warned of “fairly highly valued” assets on Tuesday, though he didn’t explicitly refer to technology firms. 

The Bank of England further warned that “downside factors included disappointing AI capability/adoption progress or increased competition, which could drive a re-evaluation of currently high expected future earnings.” 

“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,” it added. 

Meanwhile, the private credit market has suffered recently, following news that auto maker First Brands and auto finance firm Tricolor have filed for bankruptcy. Meanwhile, political uncertainty in France and Japan persists and questions remain over U.S. President Donald Trump’s interference with the Federal Reserve, adding to the Bank of England’s more gloomy outlook. 

Changes to the risk landscape “increases the risk that markets have not fully priced in possible adverse outcomes, and a sudden correction could occur should any of these risks crystallise,” the Bank of England said.

As such, it could have a knock-on effect for households and businesses in a market that is already feeling the pinch through high costs of living and borrowing costs, it added.