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Canada Bank Sees High Risk to Financial System From Europe

Dec. 8 (Bloomberg) -- Canada’s financial system faces a “high” risk of disruption linked to Europe’s debt crisis and the chance of a global economic slowdown, the country’s central bank said.

The risk of problems from a spreading of investor concerns about Europe is “very high” and has risen since June, the Bank of Canada said today in its semi-annual Financial System Review. The report also said there are high risks posed by slowing global growth and unchecked trade and budget deficits, while Canada’s financial system “remains strong.”

“The risks to the stability of Canada’s financial system are high and have increased markedly over the past six months,” the Ottawa-based bank said. “The risk is very high that a further escalation of tensions in the euro area could adversely affect domestic financial stability, particularly through a general retrenchment from risk-taking, funding pressures and confidence effects.”

The report was overseen by policy makers including Governor Mark Carney, who last month became Chairman of the Financial Stability Board, tasked by leaders of the Group of 20 nations to overhaul the global financial system. European Central Bank President Mario Draghi today coupled an interest rate cut with a pledge to offer banks unlimited cash for three years, following the Nov. 30 move by six central banks, led by the U.S. Federal Reserve, to make it cheaper for banks to borrow U.S. dollars.

‘Fallen Short’

“The measures taken to date have repeatedly fallen short of what is needed” in Europe, today’s report said, which is based on information through Dec. 2.

As Europe’s leaders craft their fifth solution in 19 months, almost half the respondents in a Bloomberg poll conducted Dec. 5-6 say one or more countries will leave the 17-nation bloc within a year and almost a third more predict an exit by the end of 2016. Thirty-seven percent say fiscal union is the most effective remedy for the current turmoil, with 24 percent endorsing a shrinking of the euro’s membership.

The Bank of Canada on Dec. 6 kept its key interest rate at 1 percent where it’s been since September 2010 and that decision also cited growing risks from Europe.

Canadian borrowing costs have declined in the bond market, with two-year government yields falling 56 basis points to 0.86 percent from six months ago, versus a 314 basis point jump in the yield on a similar Italian bond to 6.04 percent.

‘On the Sidelines’

“The bank’s preferred monetary policy stance is to remain on the sidelines for the foreseeable future,” said Mazen Issa, Canada macro strategist at TD Securities in Toronto, in a note to clients. The report also suggests the Bank of Canada will avoid taking new action unless “severe interbank funding pressures develop,” he said.

Canadian banks have “low direct exposures” to the weakest European countries and there are “modest trade links with the euro area” the report said. That may not protect Canada if there is a worldwide decline in confidence, the central bank said.

The global recovery is also strained by inflexible currencies such as China’s that add to “global imbalances” in trade and investment flows, the report said.’

“The world is experiencing the economic ramifications of an international monetary system that does not have a coherent set of exchange rate policies,” the review said.

Canada’s main domestic risk is high household debt, the report said. Consumer debts are a record 149 percent of income, and the bank said further record highs are likely.

“The elevated levels of household debt and housing prices require continued vigilance and close co-operation among Canadian authorities” the report said.

The global environment of low interest rates, which is likely to continue, is hurting the balance sheets of life insurance companies and pension funds, the report also said.

To contact the reporter on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net.

To contact the editors responsible for this story: David Scanlan at dscanlan@bloomberg.net; Christopher Wellisz at cwellisz@bloomberg.net

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