Bank of England warns hedge fund debt is inflating AI stocks
The Bank of England has warned that hedge funds are using billions of dollars in borrowed money to drive up AI stock prices. A crash could raise the cost of Britain’s national debt.
The warning comes in the Bank’s July 2026 Financial Stability Report. The report is produced by the Financial Policy Committee, the body tasked with spotting the next financial crisis.
‘There has been a significant rise in hedge fund leverage in equity markets, creating risks’, the report said. ‘Equity prices have increased especially for AI-related stocks.’
The Bank said stock prices have been driven up in part by a narrow set of AI companies. It described AI valuations as ‘materially stretched’. Borrowing by hedge funds through prime brokers has risen about 40% over the past year, with much of it concentrated in AI-related shares such as semiconductor firms.
Hedge funds can use the same stock as collateral many times over to carry out more trades. That multiplies the danger if share prices suddenly fall.
The same funds are also borrowing heavily against gilts, the debt the UK Government sells to fund its spending. Hedge fund borrowing in the gilt market reached close to £100 billion in late 2025, the highest on record. More than 90% of those positions are held by a small number of funds, most of them managed in the US.
The fear is a chain reaction. If AI stocks crash, hedge funds could be forced to dump gilts to cover their losses. That would push up gilt yields, meaning the Government pays more to borrow. Taxpayers foot that bill through debt interest. The Bank noted that hedge funds selling off debt pushed up gilt yields during the recent Middle East crisis.
The Bank presents itself as the watchdog spotting the danger. But the cheap borrowing did not come from nowhere. For more than a decade the Bank held interest rates near zero and created hundreds of billions of pounds from nothing. That flood of easy money is what allowed hedge funds to load up on debt and pump up stock prices in the first place. The institution warning about the bubble helped inflate it.
The institution warning about the bubble helped inflate it.
The Bank is now drawing up plans to limit hedge fund borrowing in the gilt market by forcing funds to put up more of their own money on each trade. Final proposals are expected in early 2027.
The report also warned that AI poses ‘a significant increase in risks’ to financial stability through cyber-attacks on banks. In the Bank’s latest survey of financial firms, 82% named cyber-attack as a top-five risk, and 26% called it the single biggest.
The warning comes after US AI firm Anthropic withheld full public release of its Mythos system because of its ability to find weaknesses in cyber-defences. The UK Government’s AI Security Institute confirmed the system’s advanced hacking capabilities in its own evaluation.
‘In a severe scenario, firms and key third-party providers could fail to keep pace, vulnerabilities could accumulate, and the risk of a systemic cyber event could rise materially’, the Bank said.
The Bank’s final proposals to rein in hedge fund borrowing are due early next year.
