(Adds economist and governor comments, details on inflation)
By Alastair Sharp and Randall Palmer
OTTAWA, June 12 Canada's financial system is
robust despite lingering concern about a stretched housing
market and low inflation, while external risks from China have
increased, the Bank of Canada said on Thursday.
The bank's governor expressed persisting anxiety over low
inflation, citing underlying price rises of around 1.2 percent,
below the 2 percent registered in April for overall inflation.
"After weighing the risks to financial stability through our
improved framework and applying judgment, our level of comfort -
or perhaps should I say our level of discomfort - as
policy-makers remains similar to what it was six months ago,"
Governor Stephen Poloz told a news conference.
Canada's central bank has walked a tightrope in recent
months, seemingly happy to let dovish implications devalue the
domestic currency in light of low inflation but wary of further
inflating a frothy housing market.
Poloz said one-off factors including an unseasonably cold
start to the year had pushed core inflation higher, and newly
minted Senior Deputy Governor Carolyn Wilkins added that the
bank was trying to look past such factors in setting policy.
"The bank will soon enter a communications challenge with
core inflation momentum ratcheting higher," Mazen Issa, a senior
strategist with TD Securities, wrote clients.
While overall inflation hit the central bank's long-term 2
percent in April, core inflation was at 1.4 percent and Poloz
pegged underlying inflation even lower, around 1.2 percent. This
figure excluded effects from the exchange rates.
"That's low and that leaves us vulnerable to a downside
shock at any time," he said.
The Bank of Canada has held interest rates since September
2010, and investors do not expect the next move, likely a hike,
until well into 2015.
Poloz and Wilkins spoke following the release of the bank's
semiannual Financial System Review, which said household debt
and overvalued housing remained the most important
vulnerability, despite tighter regulation which curbed the risk
of a housing crisis.
"While the bank continues to see a constructive evolution in
housing market imbalances and household credit, valuations are
stretched, there is overbuilding in some parts of the housing
market, and household indebtedness remains high," the bank said
in a statement accompanying the 70-page report.
It saw risks rising in China, which was "accumulating
fragilities in the banking and shadow banking sectors, in local
government finances, and in property markets."
A potential series of defaults beginning with China's shadow
banking sector could lead to a deep credit squeeze that cuts
Chinese growth, a scenario that would hit Canada through lower
commodity demand and possibly even a housing market correction,
Recent efforts by the European Central Bank to stave off
deflation have helped lower the risk of crisis there, the bank
It expressed concern about a stubbornly high Canadian
consumer debt profile, signs of overbuilding of condominiums in
key markets such as Toronto, and exposure to commodity prices
and other external factors.
The central bank defined vulnerabilities as ongoing
conditions that could magnify the effect of a shock such as a
sharp dip in house prices or a climb in U.S. interest rates.
The central bank also flagged the risk associated with
smaller Canadian institutions such as credit unions, which have
been expanding their loan books both in real estate and with
higher-risk segments of the population.
(Editing by Matthew Lewis)