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Consumer debt burden swells to record as incomes lag

These are stories Report on Business is following Friday, June 15, 2012.

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Debt burden rises
The debt burden among Canadians is swelling, not because they're borrowing that much more, but because their disposable income isn't rising faster.

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The debt-to-disposable income ratio climbed in the first quarter of the year to a record 152 per cent, from 150.5 per cent in the fourth quarter of last year.

Borrowing actually slowed in the first quarter, to 0.9 per cent, a sign that Canadians are slowing down when it comes to consumer credit and mortgage loans.

But at the same time, growth in the disposable income of families slowed because of a dip in investment income and a hike in taxes and other "social contributions," Statistics Canada said.

Having said all that, household net worth increased by 1.8 per cent as markets climbed. So while investment income may have been down, the value of equities on the Toronto Stock Exchange rose 3.7 per cent, for the second quarterly gain in a row.

"The value of total real estate assets also increased during the quarter, by just over 1 per cent," the agency said. "On a per-capita basis, household net worth rose to $185,800, from $182,900 in the previous quarter."

Economist Diana Petramala of Toronto-Dominion Bank attributed the slowing in borrowing to tighter mortgage rules from Ottawa, rather than "a responsible attitude" by consumers.

"Nonetheless, the level of Canadian household debt has become excessive as the debt-to-income ratio continues to edge towards the 160-per-cent level that pushed U.S. and U.K. households into trouble," she said.

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"Looking forward, an expected increase in personal disposable income related to an impressive turnout in the Canadian labour market through March and April should help ebb near-term advances in the household debt-to-income ratio. But, with interest rates remaining extremely accommodative, the upward trend is likely to continue through 2012. "

Only yesterday, the Bank of Canada warned its review of the financial system that Canadians are at risk should there be a shock.

"The elevated level of household indebtedness continues to be the most important domestic risk to financial stability in Canada," the central bank noted.

"There have been some welcome developments since the [last review in December] - notably, the pace of household debt accumulation has slowed and some vulnerability measures appear to be stabilizing. Nonetheless, vulnerabilities are entrenched for the most seriously at-risk households, and the bank's stress-test simulations continue to suggest that households are vulnerable."

David Onyett-Jeffries of Royal Bank of Canada expects that the moderation of Canadian borrowers coupled with faster income will put "downward pressure" on the key debt-to-income measure, but it's still likely to rise "modestly" over the short term.

"More important in our view is that the cost to service these elevated debt levels remains manageable and even incorporating our forecast that policy rates will rise by 100 basis points by the end of 2013, debt service costs will stay historically low," he said in a research note.

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"As well, households maintain a sizable net worth cushion which further serves to tone down the risks arising from debt."

While there's an argument to be made for the Bank of Canada to begin hiking interest rates again, he added, the factors outside our borders are the ones Mark Carney is watching more closely.

"From a policy perspective, while concerns regarding household debt levels could argue in favour of the Bank of Canada starting the process of normalizing interest rates, albeit at a very gradual pace so as to mitigate risks to domestic demand, recent communication from the central bank has made it fairly evident that policy is currently being guided largely by external events as the deterioration in the global economic outlook and heightened uncertainty regarding the European sovereign debt crisis outweighs domestic developments," Mr. Onyett-Jeffries said.

"Accordingly, we anticipate that the bank will wait to see how events in Europe play out over the coming months and we do not expect the first rate hike to come until the end of this year."

Home sales dip
For the first time since the beginning of the year, the number of home sales in Canada dropped in May, falling about 3 per cent from April, The Globe and Mail's Ora Morison reports.

Prices too appear to be softening. Home-buyers last month paid an average of $375, 605 for their new home, slightly less than those who purchased a year ago, the Canadian Real Estate Association said today.

"Some of the sales weakness seen in May can be chalked up to heightened activity last Spring when new mortgage eligibility criteria rules were implemented," said senior economist Sonya Gulati of Toronto-Dominion Bank. "This policy change influence should wane in the months to come."

Today's report did not change her projection for sales and price increases of 1.5 per cent to 3 per cent for the year.

"Barring any major economic shock, the catalyst for the correction in home prices will be higher interest rates," Ms. Gulati said. "The Bank of Canada must carefully balance domestic risks with the developments happening abroad when making monetary policy decisions. There is significant concern that the longer interest rates remain at current levels, home prices could be become even more overvalued than where they stand today."

Markets await Greece election
Market players are on the edge of their seats today as Greece heads toward a crucial election that could very well determine whether the euro zone remains intact.

Economists have various scenarios depending on whether the pro- or anti-austerity camps win the weekend vote, but nervous governments and antsy central bankers are primed should the results threaten further market turmoil.

As The Globe and Mail's Brian Milner writes in today's Report on Business, Britain has already unveiled forceful measures and major central banks have contingency plans.

European Central Bank chief Mario Draghi hinted as much today.

"The ECB has the crucial role of providing liquidity to sound bank counterparties in return for adequate collateral," he said. "This is what we have done throughout the crisis, faithful to our mandate of maintaining price stability over the medium term - and this is what we will continue to do."

There's a blackout on polls in the run-up to the election, though there are rumours that the pro-austerity New Democracy camp is ahead of the Syrizas forces, led by Alex Tsipras, which made surprising gains in the last election. That election left no clear winner, and no one able to form a coalition government, leading to this weekend's second round.

"The reality is whatever happens this weekend, nothing will have materially changed in Greece on Monday, as it will be increasingly unlikely that any single party will be able to form a government on its own," said senior analyst Michael Hewson of CMC Markets.

"It is more likely that we will see events unfold along similar lines after the last election as the various parties strive to form a stable government. The one differing variable could well be if Syriza comes out with the largest share of the vote, which could make markets more twitchy than normal given Alex Tsipras' recent rhetoric. Whoever wins it seems likely that Greece's future will remain uncertain given that the latest unemployment figures showed yet another increase, to 22.6 per cent."

Word of central bank preparations was enough to lift markets, and the decision by British policy makers to flood the system with cash buoyed London stocks.

Senior currency strategist Camilla Sutton has three scenarios for the euro itself:

  • Euro positive: New Democracy wins a majority and the risk of Athens quitting the euro zone falls.
  • Euro negative, but not a collapse: Syriza wins a majority and the threat rises, though negotiations with the bailout partners follow, leaving "lots of room for avoiding the worst-case scenario." That would also boost the likelihood of central bank action, though.
  • Euro neutral, and most likely: No one wins a majority, followed by weeks of talks to cobble together a coalition government. If that fails again, we'll see another election, meaning further uncertainty but with central banks still poised to act.

"Summing up the euro impact of the Greek election, the biggest risk is negative contagion; however on a psychological level the market appears increasingly willing to put a floor in euro valuations based on the potential of co-ordinated intervention," Ms. Sutton said.

Manufacturing sales slip
Canada's factories have been pumping it out, though sales slipped in the latest reading.

Manufacturing sales fell by 0.8 per cent in April, Statistics Canada said today, dragged down by the traditionally aerospace sector and energy.

It's the third drop in four months, but note that car sales hit their highest level since November, 2007, and that sales fell in 13 of the 21 industries measures, representing less than half the sector.

Inventory levels climbed 1 per cent, and the inventory-to-sales ratio, which represents how many months it would take to run out of inventories, rose to 1.32 from 1.30. Unfilled orders were flat.

"Today's data raise some doubts that April GDP will spring forward as robustly as some had been hoping, although we're still waiting on several data points out next week (wholesale, retail) before we solidify our view," said Emanuella Enenajor of CIBC World Markets.

As The Globe and Mail's Kevin Carmichael, Richard Blackwell and Tavia Grant write in today's Report on Business, the manufacturing sector has been buzzing over the past several months, with job creation leading the OECD.

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