Bank Of England Tells Markets To 'Take Heed' And Prepare For Potential Shocks

(Reuters) - The Bank of England told markets on Friday to "take heed" as the "short sharp shocks" seen in markets over recent months could happen more frequently.

Chris Salmon, the Bank's executive director for markets, said two incidents have highlighted how volatility can suddenly increase and liquidity drop.

In October last year, concerns about the global economy triggered a "flash crash" in U.S. Treasury yields, and in January this year there was a sharp rise in the Swiss franc after it was unpegged from the euro.

In both cases, markets stabilized over the following weeks to avoid spillover contagion to other markets, but this may not be the case every time, Salmon said.

"Financial markets may not have been truly tested for the ability to absorb price moves or flows that persist for a prolonged period, or for a wider spillover between markets," Salmon said in a speech in London.

"And that is why it is only fit and proper for me to finish on a cautionary note: market participants take heed."

He said the spikes in volatility in recent months have coincided with periods of much impaired market liquidity.

There were also good reasons to believe that the severity of the two events was accentuated by structural change in the fixed income, commodity and currency (FICC) markets.

"There must be a risk that future shocks could have more persistent and more widespread impacts across financial markets than has been the case in the recent past," Salmon said.

Markets should not see it as an "aspiration" to return to the "under-priced" liquidity seen before the 2007-09 financial crisis.

Recent periods of financial market volatility also suggest that there are reasons to be cautious about liquidity in core financial markets, he said.

The structure of the market has changed as market-makers say they have become more reluctant to commit capital to holding stocks of assets, which in turn has led to increased concentration in some markets.

Electronic platforms are also increasingly being used in FICC markets, which could be contributing to discontinuous pricing in periods of stress, Salmon said.