High household debt, possible housing market shocks are main risks to the economy: Bank of Canada

The Bank of Canada said high household debt and imbalances in the housing market remain key vulnerabilities in the Canadian economy.

In its annual financial system review (FSR) released Thursday, the central bank identified the main factors that could have negative consequences for the economy, while painting an overall picture of a stable financial system.

Bank of Canada governor Stephen Poloz said that progress has been made to address both issues.

"New measures have curbed borrowing, reduced speculative behaviour in housing markets and made the financial system more resilient," he said in the report.

"While the fundamentals in the housing sector remain solid overall, and the sector should return to growth later this year, we continue to monitor these vulnerabilities closely."

For the first time, the bank also highlighted climate change as a possible threat to the economy. 

"We want to better understand the risks that climate change poses to the economy and financial system," the report said. It said the Bank of Canada will begin "a multi-year research effort," as well as collaborate with domestic and international partners to build the bank's capacity to analyze climate risks.

Economic growth should pick up later this year

In a news conference with reporters, Poloz shared the bank's overall take on the economy.

"Overall risk to the Canadian financial system has increased slightly since a year ago," he said. "That's due to a slowdown to overall growth in Canada and abroad, though we do expect economic growth to pick up in Canada later this year."

On the housing market, Poloz said "previously frothy markets in Toronto and Vancouver appear to be stabilizing."

"Expectations of price increases in both Toronto and Vancouver have gone down significantly," he said, indicating "a return to market fundamentals."

"That return to fundamentals is always a positive from the point of view of financial stability."

Corporate debt rising

As for other risks, the report also points to increasing corporate debt as an emerging source of vulnerability for the economy. It said that companies around the world, including some in Canada, have become more indebted. 

"Investor appetite for high-yield bonds and leveraged loans has driven this increase in borrowing, thus making future activity susceptible to shifts in investor sentiment. We will be monitoring this closely," the report said.

Poloz said that most companies have enough liquid assets to manage their debt, but that lower-rated firms lack the liquidity to cope with changes, including interest rates. 

The review also identified possible risk to the financial system from cyberattacks. 

It said the number of cyber incidents that have or could have resulted in significant financial losses increased steadily over the past decade, according to international data.

Brian DePratto, senior economist with TD Economics, said "by definition, the FSR should give us a bit of a scare."

"Things have been getting better, but years of rising imbalances and risks can't be undone overnight," DePratto said in a written statement about the report.

"High household debt and housing market imbalances, among others, remain important vulnerabilities to the Canadian financial system. These vulnerabilities on their own may not be enough to swing the business cycle, but will worsen outcomes in the event a trigger becomes reality, such as an external shock sending Canada into an economic downturn."