Europe’s debt feared as a drag on global growth
Paul Vieira
Sun
The risks to financial stability have shot upward in the past six months, the Bank of Canada said Monday, as mounting worries over Europe’s sovereign debt threaten to freeze funding markets, derail the global recovery and trigger a “disorderly” resolution of global trade imbalances.
In its semi-annual financial system review, the central bank’s governing council warned financial stability would be on shaky ground until policy-makers in key economies — like those in the Group of 20 — agree to banking reforms designed to curb risk taking, and outline credible plans to return to more sustainable debt levels.
“While many aspects of the Canadian macrofinancial environment have improved … the governing council considers that, overall, the near-term risks to the financial system have increased,” the bank said. “Despite forceful policy actions to stabilize the global system since 2007, several of the vulnerabilities that contributed to the crisis remain, and, in some cases, may have been exacerbated.”
The report provides further clues that might help explain the central bank’s cautiousness in terms of the future path for monetary policy. While Canadian economic growth has to date exceeded expectations, Bank of Canada governor Mark Carney said last week in a speech that more rate hikes are no sure thing as aggressive budget-cutting in Europe and concern about bank exposure to sovereign debt could drag down global growth. The central bank suggested world leaders, who are set to meet at the G20 summit in Toronto this coming weekend, might want to focus on reducing the risks in the financial system.
“Safeguarding financial stability will require strong and appropriately targeted policy actions to reform global financial systems and to establish sustainable fiscal positions,” the central bank said in its review. “Until this is achieved, the financial system is likely to remain fragile.”
The bank’s risk assessment highlights how strong Canadian markets participants have held through the recession and into the early stages of the recovery, but warned domestic markets are not immune to developments across the Atlantic and elsewhere.
Over the past six months, the risks to funding and liquidity markets, global imbalances and the overall outlook have increased, the central bank said. The threat posed by household debt, which stands at record levels based on a debt-to-disposable income ratio, is unchanged from December.
The increase to the risks can be traced back to Europe, which emerged as a focal point after Greece asked for international aid to help refinance its debt. In an effort to calm market fears, European policy-makers designed a nearly $1-trillion US rescue package to help support the euro currency and backstop some of its more indebted members, such as Spain, Portugal, Italy and, of course, Greece.
“While these measures have been helpful in tempering the recent stress in financial markets, they fall short of providing a lasting solution to fiscal challenges,” the bank’s review said.
To date, the central bank said, Canadian bank funding has been largely unaffected by Europe-led pressures in short-term money markets. Yet the Bank of Canada said lending could be upended as Europe’s public finances “reawaken” tensions in some international bank funding markets.
The concern from the Bank of Canada’s view is that the “intensification” of sovereign risk could lead to tighter lending conditions, as banks hoard cash in a time of uncertainty, and governments go too far in trying to bring discipline to their balance sheets. Plus, record-low interest rates in developed economies are pushing capital toward emerging markets. The central bank said this “may be causing excessive credit growth and the creation of asset bubbles,” which heightens the risk that key developing economies, led by China, could cool down “abruptly.”
Also, pending banking reform would pose “some challenges” in the lead up to their implementation.
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