LONDON: In an unprecedented public statement on the global economy Mervyn King, Governor of the Bank of England, cautioned that shares worldwide could be heading for a major plunge.
His remarks, made while presenting the Bank's regular Inflation Report on Thursday, warned that the true impact of the US subprime crisis and the ensuing credit squeeze has yet to be felt within Western equity markets.
"It is very striking," said King, "that despite the developments we've seen in the last three months, despite the stresses and strains in the banking sector, equity prices are higher now than they were in August This is true around the world, and in emerging markets they're 20% higher. There must be some downside risks there.
"That's factored into our projections. That's the bigger risk to the global economy than the narrower one focused on the banking sector.
"The repricing of risk hasn't really fed through to equity markets, and if there were to be an adjustment of risk premia in equity markets with a fall in asset prices then that could have a bigger impact on the world economy."
Governor King's view was shared by the global head of investment banking at HSBC, Stuart Gulliver, who confirmed that world equity markets are not reflecting the prospect of slower growth ahead.
The Governor also issued an unexpectedly severe warning on currency markets, expressing "major concern" over the effects China's dollar peg is having on worldwide exchange rates and economies.
Referring to a recent session of the International Monetary Fund, he said: "I came away from the meeting more concerned about the implications of these tensions, because the unwinding of [global economic] imbalances is not just a hypothetical prospect, but is happening now. And I think this is a major concern.
"The difficulty in the world economic system at present is that a number of major economies have flexible exchange rates ... others, like China, have linked theirs to the dollar and that is causing great currency tensions."
As to the UK's financial stability, King was slightly more upbeat. "The underlying structures are sound," he said.
He expressed his confidence that UK banks will weather the coming storm, despite their current losses: "The big five banks have made over the past few years about £100bn of profits. If ever there was a moment when it was helpful for banks to have made large profits it must be now.
"They will provide the cushion which guarantees the stability of the banking system and it is strong and stable."
Data sourced from Telegraph.co.uk; additional content by WARC staff