A Bank of Canada report says an unexpected shock in the already jittery global financial markets would have a profound effect on Canada's economy, possibly threatening the viability of some companies.The central bank notes that while Canada has mostly weathered the continuing credit crunch crisis triggered by the U.S. subprime mortgage meltdown, it has not been immune. The risks of further damage to the economy remain real.The conclusions are found in the bank's semi-annual Financial System Review and help explain the bank governors' decision Tuesday to cut interest rates in Canada by one-quarter of a percentage point.The bank cited "global financial market difficulties," having "worsened since mid-October, and ... expected to persist for a longer period of time," as a key reason for its move, noting that tightening credit conditions and increased borrowing costs globally and in Canada.The review repeats some of the bank's previously expressed concerns about the unfolding financial markets turmoil, including tight credit's impact on the cost and availability of loans that businesses may need to operate and expand.As well, the slowdown in the U.S. economy from the ongoing housing crises, with as many as half a million homeowners in jeopardy of losing their homes through mortgage defaults, is already hurting Canadian producers, such as the forestry industry.Canada's housing sector faces no such crisis, the bank says in the report released Thursday, and in fact the tighter credit conditions could be doing some good in restraining potential home buyers who may not be able to afford the inflated price of homes from entering the hot market.
Overall, however, "it is unlikely there will be widespread problems" in Canada's economy, the report concludes, given"the strong balance sheets of financial and non-financial corporations."
But the bank report then asks what would happen if already uncertain financial markets are hit by an unexpected shock, such as a much deeper deterioration in the U.S. housing market.
That would shake consumer confidence more generally, the bank says, with ripple effects throughout the U.S. economy.
This would could then lead to a fire sale on assets to meet margin calls, exacerbating the tight credit problem, and trigger not just a U.S. economic slowdown, but slow global growth to the point of reducing demand and prices of Canadian commodities.
"The probability of this scenario is low," the bank report says.
"But if it were to materialize, the greater than expected slowing in the U.S., and possibly the global economy, together with a decline in commodity prices and an unexpected rise in the Canadian dollar, would reduce the profitability of Canadian exporters and increase stress on Canadian businesses, households, and financial institutions."
Under this scenario, some Canadian businesses may find it impossible to obtain financing from banks and other lending institutions. "This might threaten the viability of a number of firms," the bank review concludes.
Although stressing that the scenario is unlikely, the report does not say whether such an series of shocks could send the Canadian economy into its first recession in 16 years.
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