By David Milliken and Phoebe Seers LONDON, Oct 8 (Reuters) – Global financial markets could tumble if investors' mood sours on the prospects for artificial intelligence or the independence of the U.S. Federal Reserve, the Bank of England warned on Wednesday. The BoE said share price valuations on U.S. stock markets were similar to those seen near the peak of the dotcom bubble on some measures and noted that U.S. government bonds were vulnerable to any weakening in the Fed's credibility. "The risk of a sharp market correction has increased," the BoE's Financial Policy Committee said in a quarterly update, in its sharpest warning to date of the dangers of an AI-triggered market slump, adding that the risk of spillovers to Britain's financial system from such a shock was "material". The FPC is chaired by BoE Governor Andrew Bailey and focuses on financial stability risks. Bailey told Britain's parliament last month about his concerns over Fed independence. President Donald Trump has repeatedly urged the U.S. central bank to slash interest rates and has sought to remove one of its policymakers. "A sudden or significant change in perceptions of Federal Reserve credibility could result in a sharp repricing of U.S. dollar assets, including in U.S. sovereign debt markets, with the potential for increased volatility, risk premia and global spillovers," the BoE said. British government borrowing costs are closely correlated with U.S. Treasury yields, and a fall in U.S. bond prices would probably push up the cost of servicing new British public debt. Thirty-year gilt yields hit their highest since 1998 last month and yields for shorter maturities – where most British borrowing is concentrated – have risen too. The BoE said this increase reflected concerns about the difficulty reining in high borrowing across advanced economies, amplified by political uncertainty in France and Japan. On AI, the BoE said that 30% of the U.S. S&P 500's valuation was made up by the five largest companies, the greatest concentration in 50 years. Share valuations based on past earnings were the most stretched since the dotcom bubble 25 years ago, though looked less so based on investors' expectations for future profits. "This, when combined with increasing concentration within market indices, leaves markets particularly exposed should expectations around the impact of AI become less optimistic," the BoE said. The central bank saw little change in domestic financial stability risks, as households and businesses continued to cope with rising inflation – forecast to have hit 4% in September – and increased borrowing costs compared with past years. Risk managers surveyed by the BoE were more confident in the stability of the British financial system than six months ago, and viewed the main dangers as coming from cyberattacks and geopolitical factors. The BoE left unchanged its main tools for regulating banks. It kept the countercyclical capital buffer (CCyB) steady at 2% and after an annual review left the minimum leverage ratio at 3.25%. (Reporting by David Milliken and Phoebe Seers) ((david.milliken@thomsonreuters.com; +44 20 7513 4034)) Keywords: BRITAIN BOE/
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