Global risks rising: Bank of Canada

The Bank of Canada warned Thursday that the risk of another global economic shock is rising and Canadians may not be prepared for it.

The recovery in Canada and globally is slowing, the central bank said in the December issue of its Financial System Review.

It said the main risk is the growing seriousness of Europe's government debt crisis. Another threat is the unwillingness of countries to take action to reduce imbalances in exports and imports between countries.

Canadians won't be spared another shock, the bank said, because during the current period of tough economic times, they have continued to take on debt.

Household debt has risen to 145 per cent of disposable income as Canadians have taken advantage of super-low interest rates to purchase homes and other consumer items on credit.

The central bank has raised its benchmark lending rate three times this year, by 25 basis points each in June, July and September. Since the last announcement in October, the bank has left rates unchanged as Canada's growth slowed.

If interest rates rise, or employment falls, many Canadians could find themselves in over their heads, the bank's review said.

Rate hikes predicted in May

"Developments since (June) suggest that the vulnerability of the Canadian household sector has increased," the bank said.

"The probability of an adverse labour market shock materializing is judged to have edged higher in recent months, owing to the downward revision … to the outlook for the global and Canadian economies."

Sal Guatieri, senior economist with BMO Capital Markets, said in a commentary the review suggests the bank won't resume increasing rates until the global economy picks up and Europe's credit crisis ebbs.

"However," he said, "the bank is also cognizant of the risk to household finances (and the economy) of keeping rates too low for too long. This suggests it has every intention of guiding rates back toward more normal levels at the earliest opportunity, which in our view, is likely in May."

The review also warned of the potential for high household debt to affect Canada's banks in the event of another recession if borrowers lose their ability to make debt payments.

The potential economic problems for Canada all stem from other countries, the bank said, since it still judges the domestic financial system to be relatively sound. Those potential problems are considerable, however, and they have grown since the last time the bank reported on the financial system in June.

Global trade war

The bank said trade imbalances between consumer nations like the U.S. and producing nations like China narrowed during the recession but now have resumed widening again.

The main problem is that China and other emerging nations continue to fix their currencies at depressed values to encourage exports and discourage consumption of foreign goods.

If that continues, the bank said, a global trade war cannot be ruled out.

"The risk of real and financial protectionism has increased," it said. "Overall, the bank judges that the risk of market turmoil resulting from global imbalances is high and has risen since June."

Governments can act to reduce risks, the bank said, by reining in deficits and moving to floating exchange rates.

In Canada, it said, authorities should monitor closely the debt being taken on by Canadians.