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S&P frets about Canada's housing market, consumer debt Add to ...

These are stories Report on Business is following Monday, July 30, 2012.

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Why S&P spanked the banks
Behind S&P's warning on Canadian banks lies a troubling message, one we've heard before but bears repeating.

"The current mix of international and domestic macroeconomic conditions could bring about a rising level of unemployment and further constrain income growth for Canadian workers," Standard & Poor's Ratings Services warned late Friday.

"These developments may potentially impair consumers' debt servicing capacity and amplify Canada's vulnerability to a housing market correction at some point in the future."

As The Globe and Mail's Tara Perkins reported, S&P revised its outlook on seven financial institutions to "negative" from "stable," including Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, National Bank of Canada, Laurentian Bank of Canada, Central 1 Credit Union and Home Capital Group Inc.

"A prolonged run-up in housing prices and consumer indebtedness in Canada is in our view contributing to growing imbalances and Canada's vulnerability to the generally weak global economy, applying negative pressure on economic risk for banks," S&P said.

Like the Bank of Canada and the federal government, S&P is fretting over the fact that the ratio of debt to disposable income among consumers has climbed above 150 per cent, and consumer debt relative to gross domestic product to more than 90 per cent.

Over the 10 years in which this occurred, house prices in Canada doubled, and after the "brief correction" in 2008 surged again, now some 10 per cent above the last peak. Many observers see Canada's housing market moderating, rather than crashing.

The government's attempts to act on debt and house prices have so far "done less than we expected to counteract the growing level of consumer leverage and housing market risk in Canada," S&P said, though it does expect they will have some impact. Finance Minister Jim Flaherty brought in another round of new rules earlier this month aimed at cooling things down.

Still, Canada's economy recovery is weak given the global troubles, and this could hold back consumer spending, it said.

"Until now, consumers' debt servicing capacity has been supported by job growth in the economy and employment that is above pre-recession levels," the ratings agency said.

"Low interest rates have also supported consumer debt servicing affordability at historically favorable levels in Canada, although this factor may contribute to upward pressure on home prices, rising consumer debt levels, and consumer exposure to future interest rate increases."

Europe sets bar high
European politicians and policy makers are setting the bar awfully high. And setting up the markets for a major letdown if they don't follow through.

European Central Bank chief Mario Draghi kicked it all off last week when he promised to do whatever's necessary to save the euro, sparking a big market rally. The leaders of Germany and France followed up with similar comments a day later, and Germany's Angela Merkel went at it again with Italy's leader on the weekend.

That means a lot is at stake when the ECB meets Thursday, having set the stage for something. Markets will not take kindly to a lack of action should Mr. Draghi not follow through, having hinted he's poised to help drive down bond yields by buying up Spanish and Italian paper. Germany's Bundesbank is opposed to that.

"The rebound in markets has been fuelled by an expectation that we could well see the ECB embark on some radical new policy action to stem the flow of contagion risk in Europe and lower Spanish and Italian borrowing costs," said senior analyst Michael Hewson of CMC Markets in London.

"Spanish bond yields have dropped as a result of last week’s verbal intervention, but they still remain uncomfortably high and there is a risk that having raised expectations so much any disappointment is likely to provoke a sharp turnaround.," he added.

Sorry seems to be the hardest word, but banks are learning
The world's major banks are learning to say "I'm sorry."

First, Barclays PLC settled a Libor-rigging probe with British and U.S. authorities, its former CEO saying that "I am sorry that some people acted in a manner not consistent with our culture and values."

Then today, HSBC PLC apologized as it posted a $700-million (U.S.) hit for U.S. penalties related to money laundering control lapses in Mexico.

HSBC put aside a further $1.3-billion related to mis-selling loan insurance and hedging products.

"We apologize for our past mistakes in relation to anti-money laundering controls, and it is a priority for senior management to build on steps already taken to manage risk and ensure compliance more effectively," chief executive officer Stuart Gulliver said in a statement.

What to watch for this week
Besides the ECB, the focus this week will be on what, if anything, the Federal Reserve decides to do or say about the economic malaise.

The U.S. central bank announces its decision Wednesday.

Markets want the Fed to unveil another round of stimulus in the form of quantitative easing, dubbed QE3, while they're looking for the ECB to act on the euro crisis.

Chairman Ben Bernanke and his colleagues at the U.S. central bank are widely seen as acting at some point, though some expect it won't be this round.

They need to do something given Friday's reading of the U.S. economy, which showed growth slowing to an annual pace of just 1.5 per cent in the second quarter, nowhere near enough to ease America's jobs crisis.

"We judge that it’s only a matter of time before the Fed eases again, faced with the prospect of a flat-to-mildly-rising unemployment rate through next year," said senior economist Michael Gregory.

And, with looming November elections, it might be more convenient to move sooner rather than later (although we don’t believe the political background would stay the Fed’s hand)."

Wednesday's decision precedes Friday's key jobs report, which is expected to show job creation of about 100,000 positions in July, and an unemployment rate of 8.2 per cent.

"It’s likely only a matter of time before the unemployment rate starts drifting up, although it should still round out to 8.2 per cent in July, for the third month in a row," Mr. Gregory said.

At home, Statistics Canada is expected to report tomorrow that the economy expanded by 0.2 per cent or 0.3 per cent in May, on the heels of April's 0.3 per cent.

"Helping to boost growth, a return to normal seasonal temperatures could have seen a rise in utilities production, surprisingly absent from the prior month’s reading," said Emanuella Enenajor of CIBC World Markets.

"Wholesaling and retail volumes were also supportive that month, with the latter rebounding after a soft start to the quarter," she added in a research note.

"Factory production probably made only a modest contribution to growth due to weakness at refineries, while a late-month rail strike may not have had much impact on activity, based on existing indicators. Protests in Quebec saw an early end to the school year, likely hitting educational output; however, growth elsewhere could have been enough to lift activity by 0.3 per cent, matching the prior month’s clip."

For investors, several major companies will also be reporting results, including HSBC Holdings PLC, Deutsche Bank, Fiat, Thomson Reuters Corp., Great West Lifeco Inc., Maple Leaf Foods Inc., Talisman Energy Inc., WestJet Airlines Ltd., Enbridge Inc., General Motors Co., Kraft Foods Inc., Sunoco Inc., Valeant Pharmaceuticals International Inc., Agrium Inc., Procter & Gamble Co., SNC-Lavaline Group Inc. and Telus Corp.

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