The Bank of England Just Modelled an AI Crash — Here’s What It Found

Central banks rarely name specific asset bubbles in official reports. The Bank of England’s July 2026 Financial Stability Report comes close, devoting substantial analysis to what happens if the AI-driven equity rally that has powered global markets for two years abruptly unwinds.

A Scenario, Not a Prediction — But a Detailed One

Bank staff explicitly modelled the impact on the UK economy of a potential global correction in AI valuations, running the scenario through both equity markets and, more significantly, sovereign debt dynamics. The Bank’s own assessment is measured: an equity shock in isolation would be unlikely to present a direct risk to UK financial stability on its own.

The caveat is where the real story lives. The report warns that a reassessment of AI-related companies’ prospects could trigger a fall in equity prices that gets amplified by high concentration, correlated momentum-driven positions and elevated use of leverage — the same structural fragilities that have historically turned ordinary corrections into disorderly ones.

Why Gilt Markets Are Suddenly Part of the AI Story

The more novel finding concerns sovereign debt. In the Bank’s hypothetical scenario, debt-to-GDP ratios rise as a corrective aftershock, but the report notes that in its analysis both the US Treasury market and the UK gilt market continued to function well — with an explicit warning that had those markets come under pressure instead, the financial stability consequences could have been considerably worse.

That’s a notable acknowledgment that AI equity valuations and sovereign bond market resilience are no longer separate conversations. The Bank’s broader Financial Policy Committee analysis observes that the pace of AI-related investment is unprecedented historically, with AI companies increasingly turning to the financial system — particularly debt financing — to fund infrastructure buildouts, a trend that has accelerated corporate credit issuance across global markets.

Is the Bank of England worried about an AI bubble?

Yes. The Bank’s July 2026 Financial Stability Report modelled a global AI valuation correction, warning that concentrated, leveraged equity positions could amplify a sell-off, though it found UK gilt and US Treasury markets held up well under the hypothetical scenario tested.

The Leverage Problem Underneath the Rally

The report is candid about how narrow the rally has become. Equity price gains have been driven in significant part by a concentrated set of AI-related companies, with valuations on some metrics now stretched even as continuing positive earnings news has supported prices since the Bank’s December report. The FPC also flags a substantial increase in the use of leverage tied to these positions — precisely the mechanism that turns a valuation reset into a liquidity event.

On the credit side, the Bank notes that vulnerabilities in risky asset valuations, sovereign debt markets and risky credit — including private credit — remain, with some having become more pronounced since the previous report, as energy-driven cost increases and globally higher interest rates add pressure on corporate borrowers.

The Policy Response

Rather than attempting to deflate the AI rally directly — not a central bank’s job — the Bank is focused on shock absorption. It points to reforms already announced for money market funds across the UK and Europe, and changes under exploration to bolster resilience in the gilt repo market specifically, as the tools most likely to prevent an AI-driven equity correction from cascading into a broader liquidity crisis.

Why This Matters Beyond the UK

The Bank’s framing — that the UK and euro area are less directly reliant on the AI-financing ecosystem than the US, but not insulated from its unwind — is a useful lens for investors across every market covered in this series. A disorderly correction centred on US AI infrastructure debt would transmit through global risk appetite, currency markets and credit spreads well before it reached UK-specific balance sheets, making this less a domestic UK story than a global one told through a UK institutional lens.