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Ultra-low interest rates risk fuelling a debt bubble: BMO Add to ...

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Risks of debt bubble Consumers may be starting to tame their borrowing habits, but the lengthy period of rock-bottom interest rates risks fuelling a debt bubble, BMO Nesbitt Burns warns.

"With overnight rates unchanged since last September, household credit market debt has climbed to a fresh all-time high of $1.524-trillion in [the first quarter] or a record 147.3 per cent of disposable income," economists Douglas Porter and Sal Guatieri said in a report today.

"Canadian debt ratios are now leaving their U.S. counterparts in the rearview mirror ...despite the repeated exhortations by domestic policy makers to rein in borrowing. It seems that (interest rate) actions speak louder than words. Although household debt growth has cooled notably in recent months - April's 5.5 per cent year over year was the slowest pace since early 2002 - the plain fact remains that it continues to outstrip income growth."

Bank of Canada Governor Mark Carney has held his key overnight rate at 1 per cent for some time now, and is expected to continue to do so at least into the fall, and possibly longer. Indeed, he told The Wall Street Journal that he may need to hold rates down for a while longer given the economic uncertainties in the world.

Mr. Carney has been vocal on the need for Canadians to cut their hefty debts - as recently as this week - as the central bank fears the impact of a financial shock on overburdened consumers.

The BMO economists also cited higher debt service costs and lower equity among homeowners. Interest payments now take up 7.6 per cent of disposable income, just a shade more than the 10-year mean of 7.4 per cent, and it would be higher but for low interest rates.

That will change when rates inevitably, Mr. Porter and Mr. Guatieri said. And while homeowners have a "nice equity cushion" should house prices slump, that cushion is "losing some padding even in the face of rising house prices (as was the case before the U.S. boom turned to bust."

The BMO economists did note that there are "solid assets" among households, because of higher house prices and stronger stock markets in the first quarter. As well, a steady climb in debt ratios has eased recently.

Still, they're worried that Canadians could continue to borrow faster than their incomes rise, leading to an unsustainable debt burden among households.

"While we maintain that a singular focus on debt to gauge the strength of household finances is not entirely appropriate, the prolonged period of ultra-low interest rates runs the risk of pumping a debt/housing bubble," they said in their report.

"We are encouraged by the recent slowing in consumer debt growth, though some further cooling, especially on the mortgage side, will be required to stabilize household debt ratios. This should occur when (or if) interest rates climb moderately in the year ahead."

Investing on thought of RIM takeover 'risky' Shares of Research In Motion Ltd. have rebounded of late, partly on speculation it could be a takeover target given the recent plunge. But, National Bank Financial warned today, it wouldn't be particularly smart to invest in the stock for that reason.

"After RIM's very weak Q1 results and guidance, the stock cratered to below $26 a share," said analyst Kris Thompson.

"Over the past two days the stock has rallied on renewed speculation that the company is now a takeover target based on its perceived depressed valuation ... Our view is that a near-term acquisition of RIM is unlikely given the uncertainly in the company's strategy and ability to execute to plan. With RIM currently undergoing selective headcount reduction, employee morale will be affected and the best talent may flee the company, making it even more challenging for the company to execute its plan."

Mr. Thompson's report on RIM, which he rates at "underperform" with a stock price target of $25 (U.S.), is generally bleak. He looks at who could acquire RIM, but warns he expects its share of the global market for smart phones to fall below 10 per cent, from about 14 per cent now. And, while RIM executives have promised better times and exciting products, he questions whether it could then attain a market share above 10 per cent.

"Our valuation discussions with investors centre on RIM operating a niche enterprise business and perhaps a fringe consumer segment," he said.

"If this business could generate $1.5-billion of annual cash flow, maybe that's worth $15-billion. Add about $3-billion of cash and investments and about $5-billion for the company's patents. This would value the company at around $23-billion or $43/share (44 per cent premium to close)."

Mr. Thompson notes that few companies have the cash to swallow RIM. Those that do include Apple Inc. , Google Inc. , Microsoft Corp. and Cisco Systems .

He ruled out Microsoft because of its partnership with Nokia, and said Apple is already making big strikes in the enterprise area, and Cisco's already involved in too many product segments. Others would need debt or equity financing.

Private equity players could also be interested, but it would be hard to determine "sustainable cash flow" in such a hugely competitive industry, which is anyway likely moving to lower gross margins.

"We would not invest in RIM based on a takeover thesis," Mr. Thompson said. "We expect RIM's performance to deteriorate before potentially improving. Investors should expect the stock to be volatile over the summer months."

Separately today, The Globe and Mail's Janet McFarland reports, a major shareholder advisory firm recommended investors vote in favour of separating the roles of chairman and CEO at RIM.

Last tango in Paris Canada's Bombardier Inc. wrapped up a "respectable" showing at the Paris Air Show where its new C Series is concerned, securing an eighth customer.

The name of the European buyer wasn't disclosed, but the 10-plane deal is worth $628-million (U.S.).

"In our view, [Bombardier's]performance at the Paris Air Show was respectable with regards to the C Series orders placed," said analyst Tasneem Azim of UBS Securities Canada.

"The latest order brings the total C Series announcements at the air show to 30 orders and 26 options (including the LOI from Korea Air to be firmed up later this summer) valued at more than $1.2-billion," she said in a research note.

"The total backlog has firm orders of 123 C Series aircraft, options of 109 aircraft. We estimate this represents more than two years worth of production."

Ms. Azim added that the order "provide some relief" to Bombardier stock, which she rates as a "buy" with a 12-month price target of $8.25 (Canadian).

Greece in the spotlight Don't be fooled by Greece's deal with EU and IMF inspectors. While the threat of imminent default has passed, there are miles to go yet. George Papandreou's government still has to get the austerity measures through Parliament - the broad plan would slash the public service and hike taxes - and it seems unlikely he'll get the public on side given the strikes and demonstrations that are non-stop in the country.

It would be "naive in the extreme" to think that last night's deal will calm the markets, said CMC Markets analyst Michael Hewson.

"The first real test will come next week when the Greek parliament comes to vote on it, and given that they didn't like the last austerity budget very much, the odds are that the new one won't find much favour either," Mr. Hewson said.

"In the event the budget does get passed you then have the small matter of implementing it and that could be where it all unravels if the scenes outside the Greek parliament the other night were anything to go by. The Greek population appear to have contracted a rather nasty bout of austerity fatigue and the thought of another five years of rather unpleasant fiscal medicine may not go down that well. "

Draghi named next ECB chief EU leaders have annointed Mario Draghi as the next chief of the European Central Bank, to succeed Jean-Claude Trichet who retires at the end of October.

The Italian official will take over the helm of the central bank at a time of crisis in the euro zone, which is made up of 17 countries that share the common currency.

By the time he takes over, Mr. Trichet and his colleagues will likely have already raised interest rates again once, or possibly twice, as they make their fight against inflation a higher priority than the debt troubles of some of their members.

In my view, it's a policy mistake to raise rates at a time when the periphery can least afford it.

Let's downgrade everyone Imagine if the world's credit rating agencies had been as vigilant in the runup to the financial crisis as they have been on the post-recession woes of debt-burdened countries and their banks.

Downgrades, or the threat of downgrades, have been fast and furious, particularly where the countries at the heart of the euro debt crisis are concerned. Standard & Poor's even downgraded Moody's.

The rating agencies were publicly spanked for their performance in the runup to the crisis, villified at public hearings over their treatment of financial products many people couldn't get their heads around. They've since taken steps to address the issues, and they face a new regulatory environment.

Now they're being screamed at by governments who don't like their vigilance, or the downgrades that ultimately drive up their bond yields.

Consider how Greece's finance ministry treated Moody's in March when it slashed the country's rating by three notches: "Ultimately, Moody's downgrading of Greece's debt reveals more about the misaligned incentives and the lack of accountability of credit rating agencies than the genuine state or prospects of the Greek economy."

So what you've got are governments that can't keep their finances straight railing against agencies that couldn't get their ratings straight. That's not to suggest for a moment that the rating agencies are wrong where Greece and the others are concerned. It's just the death by a thousand cuts that's irksome.

All of this is to say that the markets toss and turn each time there's a significant downgrade, of which there have been many, notably related to Greece, which now has the lowest rating in the world.

One of my colleagues joked the other day that perhaps the agencies should just downgrade the entire world, all at once, and get it done with.

U.S. GDP revised up slightly The U.S. Commerce Department has upgraded its measure of first-quarter economic growth, but it's just a tick up and really changes nothing.

Gross domestic product expanded at an annual rate of 1.9 per cent in the quarter, up from an earlier estimate of 1.8 per cent.

That's far shy of fourth-quarter growth that topped 3 per cent, and policy makers and economists believe the economy is now in a soft patch regardless, and crippled by a high jobless rate.

In International Business today Shares of Italian fashion house Prada SpA were nearly flat in their Hong Kong stock market debut Friday, amid lukewarm investor interest for the city's most glamorous IPO of the year. The Associated Press reports.

In Economy Lab today There's no shortage of business sentiment surveys. But here's one that tries to get inside the heads of executives that tend to operate off the radar of most economists and pollsters. Globe and Mail Washington correspondent Kevin Carmichael reports.

From today's Report on Business

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