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Bank of Canada Governor Tiff Macklem speaks during a news conference in Ottawa, on Sept. 10, 2020.

Adrian Wyld/The Canadian Press

Bank of Canada Governor Tiff Macklem acknowledged that the central bank’s adoption of record-low interest rates to fight the COVID-19 economic crisis has elevated the country’s financial risks, warning that “the next few months will be crucial” in determining how well Canadian households and businesses weather the strains from the crisis.

“As much as a bold policy response was needed, it will inevitably make the economy and financial system more vulnerable to economic shocks down the road,” Mr. Macklem said in a speech through a video conference to the Global Risk Institute.

He added that even before the pandemic, some businesses and households were carrying heavy debt loads and some housing markets looked overvalued – pressures that may emerge more acutely as the government emergency support programs and banks' payment deferrals begin to expire.

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“A full recovery from the pandemic will take a long time, and many risks remain. How well all of us – individual Canadians, businesses, the health care system and governments – manage these risks will be a key factor in everyone’s well-being,” he said.

In March, in response to the pandemic, the Bank of Canada slashed its key policy interest rate to 0.25 per cent from 1.75 per cent. Since Mr. Macklem took over as the head of the central bank in June, the bank has pledged to maintain the rate at this record-low level “until economic slack is absorbed so that the 2-per-cent inflation target is sustainably achieved.” Such a return to full economic capacity is unlikely before at least 2022, economists say – implying years of near-zero interest rates ahead.

Replying to an audience question after his speech, Mr. Macklem reiterated that the central bank is "not actively discussing” resorting to negative interest rates in the event of another serious economic shock from a second wave of COVID-19. However, he said, “It’s in the tool kit, and never say never.”

In his speech, Mr. Macklem said that in response to the COVID crisis, financial institutions granted nearly 800,000 households deferrals on their mortgage payments – deferrals that have begun to expire. However, he said that so far, “the resumption of payments has been going quite well,” with relatively “few” second deferrals and even fewer delinquencies. “Obviously, this is an issue we continue watching closely,” he said.

“Some businesses are also finding it hard to meet fixed payments because the pandemic has slashed their revenues,” Mr. Macklem added. While he said that the federal government’s extension of its wage-subsidy program will help, he warned that “the longer the recovery, the greater the risk that cash-flow problems can turn into solvency issues.”

The governor said the financial system as a whole has so far weathered the rising risks well, thanks to “strong capital and liquidity buffers” at the country’s financial institutions.

Nevertheless, the central bank is keeping a close eye on the danger that the debt pressures on households and businesses will translate to elevated credit losses at banks – as well as how the banks respond.

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“We will continue to assess the risk that credit losses could become large enough and eat far enough into capital that banks need to tighten credit conditions. If this happens, our banking system would go from being a tailwind that supports recovery to being a headwind,” he said.

Mr. Macklem said the central bank is particularly keeping an eye on housing markets, as mortgages make up the bulk of Canadian household debt. Those markets have heated up as the economy has bounced back from the COVID lockdowns of the spring, although the bank has chalked much of the housing activity to pent-up demand that was released in the economic reopening, and doesn’t expect it to last.

But he indicated that if housing-related debt does become a serious concern again, as it did during the housing-market boom of 2016, “policy makers have several macroprudential tools they can use. Our experience with the mortgage-interest stress test shows how effective these tools can be.”

Shortly before Mr. Macklem’s speech, the Canada Mortgage and Housing Corporation reported that housing starts were at an annualized rate of 209,000 in September – down from the torrid August pace of 262,000, but still reflecting brisk activity in the housing market.

“[Mr. Macklem’s] statement should reinforce the view that the Bank of Canada will keep their administered rate pinned down for the next few years, even if that policy contributes to increasing vulnerabilities,” Canadian Imperial Bank of Commerce senior economist Royce Mendes said in a research note. “In that case, the [central] bank would look to other policy-makers to contain any growing risks, given that raising rates prematurely would also stunt the recovery.”

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