LONDON, Dec 16 (Reuters) – Plunging oil prices could heighten geopolitical tensions, trigger defaults by U.S. shale oil and gas firms and destabilise euro zone inflation expectations, the Bank of England warned on Tuesday.
In a half-yearly assessment of global financial risks, Britain's central bank said market concerns about persistent slow growth and political risks had risen over the past six months, and warned investors could ditch risky assets.
But one risk that had not materialised was a further threat to financial stability from Britain's previously booming housing market, though the BoE said household debt remained high.
The 40 percent fall in oil prices since June was mostly good for growth but could "reinforce certain geopolitical risks" if they stayed low, the report said.
Russia's central bank hiked rates to 17 percent on Monday to stem a rout in the rouble caused by falling oil prices and the effect of Western sanctions over its behaviour in Ukraine. But after shortly firming at the opening, the rouble hit its all-times low against the dollar and euro.
The oil price fall also risked pushing down already-low inflation expectations in parts of the euro zone.
"This, in turn could result in slower growth of nominal incomes, increasing the burden of existing debts," the BoE said.
More broadly it said worsened growth prospects in the euro zone, the destination of half of Britain's exports, compounded existing debt problems.
"A further downward revision to growth and inflation prospects could lead investors to question once again the sustainability of debt positions in the most vulnerable euro area member countries," the BoE said.
The BoE noted oil and gas firms accounted for 13 percent of the U.S. junk bond market and defaults by them could trigger illiquidity in the wider junk bond market.
Banks and companies should be aware of potential stresses in market liquidity and that their ability to sell assets in difficult times could be "illusory", the report also said.
"A further retrenchment in risk appetite ... might prompt sharp moves in market prices," the BoE said.
The BoE said structural changes to market liquidity since the crisis, such as some lenders pulling out of market making because new rules made it more expensive, "could lead to stress in funding markets".
It also drew broadly positive conclusions from its first sector-wide assessment of major British banks.
(Editing by Tom Heneghan)
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