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Prices in some credit markets are now likely to overstate the losses that will ultimately be felt by the financial system and the economy as a whole, as they appear to include large discounts for illiquidity and uncertainty, the BoE states in its Financial Stability Report. Conditions should improve as market participants recognise that some assets look cheap relative to credit fundamentals.
“The pricing of risk in credit markets seems to have swung from being unsustainably low last summer to being temporarily too high relative to fundamentals” John Gieve, Deputy Governor for Financial Stability, said. “So, while there remain downside risks, the most likely path ahead is that confidence and risk appetite will return gradually in the coming months.”
This Report sets out among others the reasons for the repricing of credit risk and deleveraging being so protracted, and why market-based estimates of the costs of the crisis are likely to overstate ultimate losses.