The economic outlook for the UK and the rest of the world has "deteriorated markedly", the Bank of England has warned.
The Bank warned on Tuesday that there were a number of downside factors that could affect the country's financial stability.
It said the rapidly rising costs of energy and fuel around the world were pushing up prices, in general, more quickly.
The Bank pointed out that while households and small firms were vulnerable to the price pressures; the banking system was comfortably able to weather not only the biggest economic contraction in 300 years over the COVID pandemic but also stagflation and the highest inflation in four decades.
The UK’s annual inflation rate rose to 9.1percent in May of 2021 from 9 percent in the previous month, the highest since 1982.
The Bank cited the Ukraine conflict as a main factor exacerbating the financial instability triggered by the COVID pandemic.
“The global economic outlook has deteriorated markedly,” the governor of the Bank of England Andrew Bailey said at a press conference in London.
"Commodity price volatility following the Russian invasion of Ukraine has further exacerbated price pressures facing households and businesses, and has had implications for the financial system," the Bank said.
The bank also warned that increased inflation pressures might lead to a further sharp tightening in global financial conditions.
"Tighter conditions would increase the pressures already facing households and businesses and the serviceability of public sector debt in some countries, including in the euro area," it said.
"These pose risks to UK financial stability through economic and financial spillovers," it said.
Developments around the war in Ukraine would also be key, the Bank added.
British banks were well-placed to weather even a severe economic downturn, the UK’s central bank said, although it said their capital ratios, while still strong, were expected to decline slightly in the coming quarters.
Members of the Financial Policy Committee confirmed that the Bank will double the counter-cyclical capital buffer rate to 2 percent of risk-weighted assets in July next year, and said it could vary the rate depending on which direction the global economy moves.
Despite a worsening cost-of-living crunch, with inflation heading towards double digits, the Bank said UK’s financial institutions were resilient to debt vulnerabilities among households and businesses.
The central bank also expressed concern over the performance of core financial markets such as US and British government bonds which were the subject of the March 2020 "dash for cash" when the COVID prompted panic selling among investors.
"Amid high volatility, liquidity conditions deteriorated even in usually highly liquid markets such as US Treasuries, gilts and interest rate futures," the Bank said.
It added also that core British markets had become more expensive to trade, with bid-ask spreads on short-dated gilts more than doubling compared with their 2021 average.
"(Conditions) could continue to deteriorate, especially if market volatility increases further," the Bank warned.
It said an in-depth analysis of the functioning of the commodities market will be conducted in 2022 with a stress test of banks, which was delayed due to the Ukraine conflict, in September, with the results likely to come out in mid-2023.