MNI ANALYSIS:Household Debt To Still Complicate BOC Tightening

By Yali N'Diaye

     OTTAWA (MNI) - The Bank of Canada is about to release its latest assessment

of risks to the financial system Tuesday, and elevated household debt is more

than likely to continue to top the list of vulnerabilities.

     Looking at rating agencies' expectations, household debt is only expected

to increase next year, although at a slower pace.

     "We do not feel that it is likely that household debt will decline in

2018," Moody's analyst David Beattie told MNI.

     So is Fitch's belief, according to its 2018 outlook on Canadian banks:

"household debt is unlikely to decrease in 2018, making borrowers sensitive to

negative changes in unemployment and/or a rapid increase in interest rates,"

said the rating agency.

     Moody's, like its peers, is still anticipating a "soft landing" of the

housing market and a slowdown in the pace of household debt expansion.

     That being said, "a more severe scenario remains as a possibility." In

addition, Moody's pointed out in a recent global banking outlook that 30% of

consumer loans in Canada are unsecured.

     It is that possibility that will continue to complicate the BOC's

tightening process going forward.

     The BOC has been voicing its concern over household debt, underlining once

again in its October policy statement that, "because of high debt levels,

household spending is likely more sensitive to interest rates than in the past."

     This sensitivity to interest rates will guide the central bank in its

upcoming decisions, it repeated, along with inflation and wage growth, as well

as economic capacity.

     In its June Financial System Review (FSR), the BOC estimated that the risk

of a negative foreign demand shock leading to a severe recession was low,

although the implications could be "very high."

     Given the recent turn for the worse of NAFTA negotiations, there is a

possibility the probability of such a risk materializing could increase.

     In its October policy statement, the central bank indeed underlined the

"substantial uncertainty about geopolitical developments and fiscal and trade

policies, notably the renegotiation of the North American Free Trade Agreement."

     However, S&P Global commented in its latest rating update, which left the

country's triple-A intact, that "the combination of good governance, a flexible

economy, monetary and exchange rate flexibility, and a highly skilled workforce

should allow Canada to adjust to a potential loss of its current favored access

to the U.S. market without serious long-term economic disruptions."

     When the BOC releases its FSR Tuesday at 10:30 am ET, it is also likely to

continue to express confidence in the resilience of Canadian banks.

     S&P Global said that although high household debt remains a key

vulnerability, "adequate banking-sector capitalization, strong regulation and

supervision, and high levels of fixed-rate mortgages help mitigate the

vulnerability."

     Besides, said Moody's, Canadian bank profits should allow them to absorb

loan losses in case of financial stress, while Fitch Ratings said "solid

fundamentals" do support the outlook for Canadian banks.

     In addition, tighter macro prudential rules, especially when it comes to

stress tests that more households will have to pass to qualify for mortgages

starting in January, should improve the quality of borrowing, the BOC itself has

said.

     So overall, the BOC is unlikely to express concern about the resilience of

the Canadian banking system while reaffirming household debt as a key

vulnerability.

     Last June, in addition to high household debt, the BOC identified housing

market imbalances, fragile fixed income market liquidity as well as cyber

threats as the four main vulnerabilities.

     It said the main risks were a nationwide severe recession in the wake of a

negative foreign demand shock, a house price correction in overheated markets, a

sharp rise in long-tern interest rates, as well as stress emanating from China

and other emerging markets.

--MNI Ottawa Bureau; +1 613 869-0916; email: yali.ndiaye@marketnews.com

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