Bloated levels of household debt threaten to dampen Canada's economic rebound as consumers focus on paying their bills rather than spending freely.
Household debt has more than doubled from 1989 levels and now stands at a record $1-trillion - or $1.47 for every dollar of disposable income. With the Bank of Canada expected to raise interest rates, perhaps as early as next week, vulnerable Canadians could soon find themselves emptying their pockets to cover higher interest payments.
"The high rate of household indebtedness is a source of risk" to the Canadian economy, the Organization for Economic Co-operation and Development cautioned in a report Wednesday. It noted that household debt has swelled further in recent months - an unusual development. People usually save during recessions.
The combination of higher interest rates and large amounts of debt could reduce consumer spending - a cornerstone of the Canadian economy and an essential component of the country's recovery from the recession. High levels of debt also leave consumers financially vulnerable if they fall ill or lose their jobs.
Strategists had thought that a June 1 rate hike was a done deal after a string of stronger-than-expected Canadian economic reports. Their certainty has ebbed, though, as European debt problems shake global confidence. The OECD thinks the Bank of Canada should act swiftly to raise rates to prevent the economy from overheating.
The unclear outlook for rates has Canadians such as Alice Tracey concerned about their finances. The massage therapist in Ottawa spends 50 per cent of her income paying down the credit card debt and student loans she accumulated while building her business, and is already feeling short on cash. Even a small boost in interest rates will force her to revisit her plans to attend school to become a chiropractor.
"It really sucks that I had to spend a lot of money to get set up and now I'm kind of trapped in a cage if rates go up too much," she said. "I've already cut back on expenses - I don't buy fancy clothes, I don't eat out. I don't want to be in a situation where these debts are just impossible to pay off."
Regardless of the effect on consumers, the OECD said the Bank of Canada should boost interest rates "without delay" throughout this year and next so that the economic recovery doesn't spin into an asset bubble fuelled by easy money.
"The Bank of Canada should start normalizing its policy rate without delay and tighten gradually throughout the projection period" of 2010 and 2011, the OECD said in a global economic outlook. It also boosted its growth forecast for the Canadian economy, to 3.6 per cent this year and 3.2 per cent next year.
There's no guarantee the central bank will raise rates, but if it does economists are expecting no more than a 25-basis point increase. (A basis point is 1/100th of a percentage point.) Consumers are sitting on a lot of debt, so even small increases will serve the purpose of cutting spending and cooling the economy, CIBC economist Benjamin Tal said.
"What the levels of debt mean is that monetary policy will be extremely effective in slowing down consumers," he said. "There will not be more delinquency - debt repayment will come at the expense of consumer spending."
Consumer spending is something that Ed Laverty watches closely. He has been selling high-end audio and visual equipment at Kawartha TV & Stereo in Peterborough, Ont., for 35 years, and said every sale is a vote of confidence in the economy.
"People become much more cautious about what they spend when things are uncertain," he said. "Sales came back pretty good this year, but they've levelled off. Things are tolerable, but we sure wouldn't mind going back to early 2008."