By James Langton

(December 14 – 11:35 ET) – The Bank of England’s latest Financial Stability Review is spooking traders in Europe today.

Commenting on the bank’s view, David Clementi, Deputy Governor for Financial Stability, said, “Risks in the financial environment have probably increased somewhat in recent months, reflecting weaker growth and tighter credit conditions in the United States, renewed pressure on some emerging market economies and a substantial build-up of debt in the telecoms sector.”

The review says the central question for financial firms and regulators is the possible effect of a hard landing in the U.S. economy. “One particular issue is whether a cyclical slowdown in measured productivity growth in the U.S. might lead to a downward revision of expected potential growth and so of expected growth in corporate earnings, potentially prompting changes in asset prices, saving behaviour, and possibly exchange rates.”

The review also highlights the risk arising from the substantial increase in exposures to the telecoms sector, noting that these risks may have increased somewhat since June, and that regulators, central banks and financial authorities generally need to share information on developments in this area.

It observes that equity market valuations may now be more realistic if the new economy has indeed brought sustainable productivity improvements. However, “The rates of expected dividend growth implied by current equity prices nevertheless continue to look high compared with the past.”

Finally it notes that the development of the credit derivatives market, and the involvement of onshore and offshore insurance companies and vehicles, is making it more difficult to assess the distribution of risk in the system.

“In the face of this, financial systems in the industrial countries nevertheless remain generally robust, so that the risks of instability should not be exaggerated,” says Clementi.