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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
[TOPICS: M$C$$$]