For the time being, reminding Canadians to be “prudent” may be all Mr. Carney can do. Raising interest rates sooner than the middle of next year might cool the housing sector, but could carry the cost of sending the strong Canadian dollar even higher, causing more problems for the country's exporters.
Eric Lascelles, a top strategist at TD Securities, said the central bank's warning is more likely to be addressed through regulations, such as increasing the minimum down payment or shortening the maximum acceptable term, steps taken just last year by the Harper government.
Finance Minister Jim Flaherty told reporters Thursday that the government is “watching and monitoring'' and would consider tightening rules if necessary, but currently has no plans to do so.
“People have to make sure that the mortgages they take out today either have a fixed rate or that they'll be able to handle increases in that mortgage rate later on,'' he said. “That's just prudent household management.''
The central bank said in its report that household debt will be “a key vulnerability over time,'' and in the stress test model assumed that the ratio of debt to income would rise from 1.42, or 142 per cent, in the second quarter of this year to 1.60, or 160 per cent, by mid-2012.
“Although Canadian household debt as a share of personal disposable income is lower than in the United States and the United Kingdom, its upward trend implies that households have a growing vulnerability to additional adverse shocks,'' the bank said.
At the same time, low interest rates have helped Canadians cut the amount of income that they need to devote to servicing debt, the bank said.
The proportion of households with debt-service ratios above 40 per cent of income, would rise to 8.5 per cent by the second quarter of 2012 assuming the central bank's key rate is 3.2 per cent, the Bank of Canada said. The share would increase to 9.6 per cent with a benchmark rate of 4.5 per cent. That compares to 6.1 per cent over the past decade and a peak of 7.4 per cent in 2000.
That said, the central bank said Canadian banks currently have more than enough capital on hand to absorb potential losses, suggesting that even the worst-case scenario in the stress test would fall short of risking a collapse of the financial system.
In its last review published in June, policy makers used a model based on a more severe recession and a resulting increase in unemployment.
With files from Bill Curry and Kevin Carmichael in Ottawa
