What's going on?

The Bank of England set out its major market concerns yesterday in its quarterly update. It pointed to low growth in the Eurozone, the debt crisis in Greece and China�s slowing economy as the major risks that could cause �sharp adjustments� in financial markets. It also expressed concerned about liquidity in financial markets; liquidity refers to how easy it is to buy and sell assets.

What does this mean?

Low growth in the Eurozone, the Greek crisis and the slowing Chinese economy are all risks that the market is very much aware of; circumstances could certainly get worse for each of those issues, but the probability of them doing so can be said to be �priced in� to the market given current expectations. The concern the BoE raises about liquidity is interesting, though, and often not widely appreciated by the investing public.

Why should I care?

Most of the time, the market for popular investments such as government bonds, high quality corporate bonds and blue-chip stocks are reasonably liquid � meaning that, in moderate sizes at least, investors can expect to buy and sell these investments at the current market price. However, when prices are moving in a volatile manner (especially if they are moving sharply lower), liquidity can �dry up� extremely quickly. The huge increase in bank regulations that has occurred since 2008 has led banks and other market makers to hold much fewer stocks and bonds on their own books, meaning they are less able to help manage market liquidity in times of stress. As a whole, the financial system is much more prone to sharp price movement. For long-term investors this may not be a major problem, but it will almost certainly exacerbate dramatic price movements in the future and investors should be mentally prepared for a sometimes very rocky ride.