BOE Sees Threat to Government Bonds in AI Growth Miss

A failure of AI to deliver a hoped-for acceleration in productivity and economic growth could deliver a fresh blow to prices of government bonds, the Bank of England warned Wednesday.

In a quarterly report, the Financial Policy Committee said threats to the proper functioning of the financial system have increased over recent months as the war between the U.S. and Iran has continued.

Since the war began, prices of government bonds have fallen, pushing their yields higher and increasing costs for other types of borrowing, such as mortgages.

Those price declines largely reflect the pickup in inflation driven by the rise in energy prices since late February. But investors are also concerned about a steady rise in debt levels.

The FPC said that while the financial system has so far been “resilient” as yields have risen to multiyear highs, “the risk of a sharp adjustment remains.”

A fresh source of worry is AI, which has already delivered a boost to growth in the U.S. and parts of Asia that it is hoped will spread to other parts of the world.

But the scale of the boost to growth from the deployment of AI is highly uncertain. Should those hopes be disappointed, government bonds may lose some of their appeal to investors, the BOE warned.

“Growth prospects and fiscal outlooks depend in part on expectations that AI development and adoption will generate significant productivity gains,” the BOE said. “A reassessment of those expectations could therefore affect not only AI-related asset valuations, but also sovereign debt markets.”

The BOE also highlighted the increased use of debt issuance to fund the development of AI models, which it said now exceeds the sums borrowed by many governments, including that of the U.K..

“This increased the extent to which developments in AI affect a wide range of investors and funding markets,” the BOE said.

Another concern for the BOE is the behavior of new AI models, some of which “have taken unexpected actions” and could potentially disrupt the functioning of computer networks essential to the financial system.

In a separate note, BOE Gov. Andrew Bailey warned that AI models threaten to operate outside the traditional frameworks for ensuring that the collective good is protected from individual actions.

“A sufficiently powerful system functioning within a self-reinforcing loop risks reducing the ability of society to exercise meaningful oversight and intervention,” Bailey wrote.

The central bank’s concerns are increasingly shared by banks and other financial institutions. The BOE’s twice-yearly survey of 57 firms found that 63% were worried about the risks arising from AI, a jump from 31% at the start of the year.

“This represents one of the largest movements in recent survey rounds and moves AI-related risks from a relatively lower ranked concern to the third most cited risk,” the BOE said.

Write to Paul Hannon at paul.hannon@wsj.com