British businesses and households are coping so far with higher interest rates but there are risks ahead for the financial sector from higher borrowing costs and changes to the way banks fund themselves, the Bank of England said.

"The overall risk environment remains challenging, reflecting subdued economic activity, further risks to the outlook for global growth and inflation and increased geopolitical tensions," the BoE said on Wednesday.

In its half-yearly Financial Stability Report, the BoE said stronger-than-expected wage and income growth since its last review in July had reduced some of the strain for households.

"Nevertheless, household finances remain stretched by increased living costs and higher interest rates, some of which has yet to be reflected in higher mortgage repayments," the BoE's Financial Policy Committee said.

Businesses had also been broadly resilient to higher rates and weak growth "but the full impact of higher financing costs has not yet passed through to all borrowers," it said.

The British central bank, worried about the long-lasting impact of last year's surge in inflation, raised interest rates at 14 meetings in a row between December 2021 and August this year to a 15-year high of 5.25% where they have sat since.

BoE officials acknowledge signs of a slowdown in the economy but say they are not thinking about cutting the Bank Rate because of signs that inflation pressure will stay strong.

The BoE said that it was urging banks to plan ahead for potential challenges in the way that they fund themselves, given a switch in deposits from normal current accounts to fixed-term, higher-interest savings which cost them more.

"The UK banking system is well capitalised and has high levels of liquidity," the BoE said, adding that net interest margins have probably peaked but profitability was expected to remain robust.

However, the run on Silicon Valley Bank in the United States earlier this year highlighted how lenders could be hit with sudden surges in withdrawals and the prospect of digital currencies also had implications for the stability of deposits at lenders.

Risks flagged by the BoE included upheaval in China's real estate market which could worsen, and the tensions in the Middle East which could push up oil prices and hurt economic growth.

Outflows from funds invested in risky corporate debt and increased short and long positioning by hedge funds and asset managers in U.S. Treasuries could fuel further market volatility, the BoE said.

The central bank said it would monitor in 2024 the risks posed by the rise of artificial intelligence. (Reporting by Huw Jones and William Schomberg) Keywords: BRITAIN BOE/