The Bank of Canada released its 78-page Financial System Review highlighting key risks and vulnerabilities to the financial system this morning. Benjamin Reitzes, senior economist and vice president of Economic Research, just distributed a quick summary.
-According to the June review, the risk of a “sharp correction in house prices” is “elevated” due to the potentially severe impact. Such an event is seen as a low probability, an unchanged status from the December report. The BoC continues to expect housing to see a soft landing.
-The risk of a “sharp increase in long-term interest rates globally, including in Canada, likely resulting from an overshoot in U.S. long-term interest rates” is rated as “moderate” due to low probability. This is unchanged from the December report.
-A third stress, that of “a severe financial disruption in China associated with a significant slowdown in Chinese economic growth” is rated as “elevated.” The troubling deceleration in China since the December report has seen this risk increase.
-The last big risk, a “serious financial stress from the euro area with global consequences” is rated as “elevated” but has been downgraded since December.
According to Reitzes, three key vulnerabilities may serve to amplify shocks--imbalances in the Canadian housing market, elevated levels of Canadian household indebtedness, significant exposures to potential external shocks.
Some extra interesting tidbits: Governor Poloz notes that underlying inflation remains low. This means "inflation is vulnerable to a negative shock." Poloz also admitted that inflation rose “a little faster than expected” and that CPI is nicely above the BoC’s April MPR forecast. Though, the rise in inflation is being driven by “temporary factors.”
The bottom line according to Reitzes: “The Bank remains concerned about housing and household indebtedness. Other worries (a China growth slowdown, Euro Area financial stress and a jump in U.S. interest rates) are external…risks and vulnerabilities haven’t worsened much, if at all, over the past half year. The BoC will keep an eye on the evolution of these factors, but it’s unlikely they’ll take a more prominent role in near-term monetary policy.”