24 July 2026: Popping the ‘AI bubble’ would trigger an interest rate response

Bank of England Governor Andrew Bailey remains concerned about the growth of AI for two significant reasons. First, he believes that the considerable funding AI startups require, without delivering tangible results, could lead to a market crash if they fail to generate the revenue they projected. That could trigger a crash that wipes out up to 20% of the value of the entire market and set off contagion that would affect unrelated stocks.

His second concern is that one of the major AI platforms could ‘go rogue’ because financial markets do not fully appreciate what the platforms are capable of.

Bailey has warned that if the AI bubble bursts, the resulting shock to markets and the UK economy could be severe enough for the Bank to adjust interest rates to stabilise conditions.

AI stocks are extremely concentrated: AI-related firms now make up around 50% of the S&P 500, up from 25% in 2022, while capital expenditure expectations have exploded, with projected AI-related capex jumping from < $600 billion to > $1 trillion in the six months to June.

UK investors are heavily exposed: pension funds, insurers, and retail investors hold large positions in US equities, meaning a correction abroad would hit the UK directly.

Bailey sees this as a ‘triple whammy’ in which the market is skewed towards one-sided bets on AI stocks, there is uncertainty about the real speed of adoption, and there are no clear long-term winners.

If an AI‑driven shock hits growth, the Bank may need to cut rates to support the economy, even if inflation remains a concern. This is the monetary‑policy angle behind the concern: the AI boom is now so large and so intertwined with global markets that its collapse would force a policy response.

The intense heatwave that swept across Europe in June has cost the UK economy an estimated $1.5 billion, Bloomberg reports.

The report said the temperatures recorded during the heatwave were the highest ever observed in Europe.

The extreme weather is also believed to have caused approximately 2,700 excess deaths across England and Wales.

According to Bloomberg, the sharp rise in temperatures led workers to reduce their working time by an average of 30 minutes over the five days beginning on June 22.

Employees in physically demanding jobs, including construction and agriculture, cut their working hours even further, while 3.6% of those surveyed stopped working altogether during that period.

Scientists have warned that the record-breaking summer temperatures will have lasting economic consequences.

Researchers from 12 European countries said the heat accelerates soil moisture loss through evaporation, making drought conditions 80 times more likely.

They have projected that crop failures, lower water levels in navigable rivers, and disruptions to energy production, including at nuclear power plants, could contribute to higher inflation.

John Healey is poised to revive Britain’s bid to join an international banking scheme to boost defence spending, after his predecessor, Rachel Reeves, refused to back it.

The new Chancellor quit as defence secretary last month over the failure of Reeves and the Treasury to secure funding for rearmament – a move widely seen as the final straw that forced Sir Keir Starmer’s resignation.

But journalists have learned that discussions about joining the Defence, Security and Resilience Bank (DSRB), a Canadian-led scheme that helps member states finance defence projects at lower cost, took place within Andy Burnham’s transition team before he took office.

Sterling softened slightly yesterday, slipping against most major currencies, with GBP/USD closing around 1.3315, down about 0.44% on the day. The move reflected softer UK inflation data and steady rate expectations rather than any major market shock.

Market analysts are moving fast, and repricing has turned sharply hawkish around Fed Chair Kevin Warsh. In just one week, traders have shifted from near-certainty that the FOMC would hold rates steady to assigning a meaningful chance of a hike at the July 29 meeting, now less than a week away.

Traders now assign a 28% chance of a rate increase at the July 29 meeting, up from just 3% on July 16. That is a 25% repricing in seven days.

The shift extends beyond July. On a separate full-year basis, the odds of at least one Fed rate hike in 2026 have climbed to 72%, up from 52% on July 16.

U.S. applications for jobless benefits tumbled to the lowest level in more than five decades last week, as layoffs remain historically low despite global economic uncertainty.

The number of Americans applying for unemployment benefits in the week ending July 18 fell by 22,000 to 187,000, the Labour Department reported on Thursday. That's the fewest weekly applications since the week ending Sept. 6, 1969, according to Labour Department data.

This is also well below the 215,000 new applications forecast by analysts surveyed by the data firm FactSet.

Weekly filings for unemployment benefits are considered a proxy for layoffs and are close to a real-time indicator of the health of the U.S. job market.

Despite surging oil prices resulting from the U.S.'s military attack on Iran, the American job market remains healthy, and layoffs are historically low. However, analysts say a prolonged war and higher-than-normal energy costs could eventually erode that, forcing companies to reduce costs by lowering headcounts.

The economic crisis caused by the energy supply shock is not over yet. But the labour market has yet to show any sign of wear and tear from the surge in oil prices.

The price for a barrel of U.S. crude surged nearly 5% early yesterday to more than $91. That's the highest level in about six weeks. Petrol prices in the U.S. are also back up above $4 a gallon on average. That not only squeezes consumers' budgets but also hits businesses hard, especially those that are heavily dependent on fuel prices.

Federal Reserve Chairman Kevin Warsh may hope to stay silent about the Fed's rate plans, but fresh oil price swings and potential tariff shocks, along with a hawkish tilt among his colleagues, are likely to test that resolve when the FOMC meets next week. We have already entered the ‘blackout period’, so FOMC members will also be tight-lipped until after the meeting.

The Fed is expected to keep its policy interest rate steady in the 3.50%-to-3.75% range, where it has been since December. Still, consensus may be harder for Warsh to build as oil prices rise again, President Donald Trump prepares yet more tariffs, and some of his colleagues are already laying the groundwork for a rate hike.

Canadian Prime Minister Mark Carney has said that Canada is intensifying negotiations with the United States to reach a comprehensive trade deal, but is prepared to respond if President Donald Trump’s threat to impose 50% tariffs on Canadian goods takes effect.

The new tariffs, announced by Trump on Monday, are scheduled to take effect on Aug. 19.

“If these tariffs, or other measures, come into force, there’s a full range of things we can do,” Carney said after meeting with Canada’s premiers and territorial leaders.

Carney said “everything’s on the table” if an agreement can’t be reached before the tariffs take effect.

“We don’t need to respond in advance,” he said. “In fact, I think it would be counterproductive at this stage”

The new tariffs cover a wide range of goods, including honey, liquor, cement, dairy products, some wood products, hockey sticks and other items. They exclude energy products, potash, fish and critical minerals, but would include goods previously protected from import taxes under the United States-Mexico-Canada Agreement (USMCA). That 2020 trade pact was not renewed by the U.S., triggering an agreement that could run until 2036.

Carney said the tariff threat may be little more than a negotiation tactic by the U.S.

“We’ve seen a series of trade negotiations that the U.S. has undertaken, and normally there’s a deadline,” he said. “Normally there’s an outsized tariff associated with that deadline.”

Carney believes there is a willingness among U.S. officials to reach a trade deal. deal.

The U.S. Dollar Index (DXY) was essentially flat yesterday, closing at 101.42, down 0.03%, a minor move that signals a stable dollar in the absence of major macro catalysts.

The ECB is hostage to oil prices. This is a very real constraint: energy costs dominate eurozone inflation, leaving the European Central Bank with far less freedom to set interest rates based purely on domestic economic conditions.

That isn’t an opinion; it’s a structural feature of the eurozone economy that economists and ECB officials themselves regularly acknowledge.

For this reason, the Governing Council of the ECB, having voted to leave official interest rates unchanged yesterday, left the ‘door ajar’ for a further rate hike in September. This allows them to contemplate rising inflation while at their beach villas in Spain, France or Croatia, and to return to Frankfurt galvanised for the challenges ahead.

Yesterday’s decision met market expectations, but the Bank warned of inflation risks from surging oil and gas prices fuelled by the escalating Middle East conflict, signalling a potential rate hike in September. The ECB is closely monitoring second-round effects of the energy shock, with markets pricing in three further rate increases over the next year. Eurozone inflation is expected to remain around 3%, well above the 2% target, for the foreseeable future.

The European Central Bank will discuss raising banks’ minimum reserve requirements, ECB President Christine Lagarde said at yesterday’s press conference, opening the door to a move that would cut the ECB’s own tax bill and mitigate losses at some National Central Banks.

Last month, sources told Reuters that the ECB was considering doubling the proportion of cash that lenders must keep in an unremunerated account as a buffer in case of a liquidity crunch. Such a change would considerably reduce the interest they receive from their national central banks.

Lagarde said the topic was not discussed at the meeting, but would be in the future.

"On the minimum reserve requirement, it was not discussed on the occasion of this Governing Council, which doesn’t mean to say that it will not be discussed going forward," Lagarde told her regular news conference. "It will, as it has been."

Last month, sources said a decision was likely to come in the autumn.

Commercial banks must currently keep 1% of their deposits and some other forms of short-term liabilities in reserve at their respective Central Banks. Doubling that to 2% would save the ECB and the 21 National Central Banks of the Eurosystem nearly €4 billion per year, according to calculations by Reuters.

The Euro weakened yesterday, slipping against both the dollar and the pound. The move was driven by the ECB’s rate decision, rising oil prices, and cautious market sentiment.

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