The Bank of England has sounded the alarm over a sharp increase in artificial intelligence (AI) risks amid soaring stock markets and cyber attack fears.

A twice-yearly assessment by the Bank highlighted the increasing frenzy for AI stocks including the recent market debut for SpaceX.

And it also pointed to the risks that could be posed by the rapid advances in the technology itself as cyber attacks threaten banks’ IT systems.

The Bank issued the alert as part of its Financial Stability Report, its regular assessment of risks to the UK financial system.

It comes as borrowers are facing higher interest rates as a result of the Iran war, which has driven up energy prices and inflation.

The Bank has already warned that this would mean higher bills for mortgage borrowers. It expects five million will see their monthly repayments rise, typically by £45, by 2028. That is up from four million predicted before the Middle East conflict.

Rate rise fears have abated since Iran and the US signed a deal to end the conflict.

But the Bank cautioned that other risks to the financial system remained and were in some cases higher – notably those linked to AI.

Having already highlighted the risks of an AI-related stock market bubble, the Bank said that since the end of last year valuations had become even more stretched.

And there has been a ‘significant increase’ in leverage by hedge funds in stock markets – the practice of borrowing money using shares as collateral.

Ordinary savers have also piled in via exchange-traded funds (ETFs).

Meanwhile, AI firms themselves have also stepped up borrowing to fund huge infrastructure investments. Yet earnings growth remains ‘highly uncertain’ and depends on the continued progress on these investments and the adoption of AI across the economy, the Bank noted.

‘A reassessment of these prospects could trigger a fall in equity prices,’ it said – sparking major knock-on consequences.

And there was a stark warning over the need for banks to guard against the risks of ‘frontier AI’ – the latest cutting-edge technology that could add to risks of cyber attack.

‘Recent rapid advances in frontier AI capabilities have increased financial stability risks related to cyber and operational resilience,’ the Bank said.

These may make ‘faster, larger-scale and more correlated disruption more credible’, it said.

‘The issue is not that cyber risk is new, but that frontier AI may materially change its speed, scale and economics,’ the report said.

Alongside the report, the Bank announced plans to ease some of the post-2007 rules governing the amount of capital lenders must hold to guard against a financial shock.

Requirements were scaled back to bring the UK regulations more into line with global peers and will particularly benefit domestically-focused lenders such as Natwest, Lloyds, Nationwide and Santander UK.