But there was not a wider market reaction at that point. It was Bernanke’s comments on May 22nd that the FOMC could begin tapering its asset purchases “in the next few meetings” which caused a widespread reassessment of risk positions. What followed was a good illustration of what can happen when there is a general sell-off. Initially asset price correlation increased and liquidity became poor across markets. Because the news related to a prospective policy tightening, risk-free yields generally rose (Chart 3), although at least some of this was a change in term premia rather than rate expectations. Equity markets fell. Some contacts described conditions as highly volatile. EME assets in particular were badly affected as leveraged investors cut their risk positions quickly in those markets (Chart 4). Eventually, as conditions settled, there was more discrimination between and within asset classes. For example, there has been much more distinction between those EMEs whose fundamentals were seen to be relatively sound and those who were seen to have challenges – in this latter group were especially those with both a large external deficit and high inflation.
Both borrowers and lenders need to be careful not to over-stretch themselves. In line with the recent FPC statement, we will be keeping a very close eye on developments, and the Bank has a range of tools that can be used in mitigation of those risks. Stage 4: the flow of credit Annual growth in the stock of lending to households and businesses has remained close to zero since mid-2012, similar to rates seen in the run-up to the launch of the FLS. But it is important to bear in mind that prior to the announcement of the FLS, the Bank judged that UK bank lending was more likely to decline than increase over the following eighteen months. The profile of lending seen to date has been broadly in line with our original expectations: the trend in household net lending has been somewhat stronger than expected before the launch of the FLS and net lending to businesses has been perhaps a little weaker. We were also conscious that the stock of credit depends on both supply and demand. We were sure that the FLS would shift supply but the demand effects were always less certain. The price elasticity for firms in particular is likely to be low. It is possible at the margin that some firms will be better able to repay or refinance loans if their borrowing costs are a bit lower, but this effect is probably small relative to the importance of expected demand for a firm’s products.