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OTTAWA (Reuters) - The Bank of Canada warned on Thursday that the country's red-hot housing market could start to cool soon, a prospect that would strain the financial system and put households carrying too much debt under intense pressure.
In its semi-annual Financial System Review, the central bank ranked the housing market and high household debt as the two biggest domestic risks to Canada's financial outlook.
Moody's Investors Service's chief analyst for Canada voiced a similar view on a pullback in housing during an interview on Thursday, while a report by a government housing agency raised red flags as well.
"The continued high level of activity and stretched valuations in some segments of the housing market are of increasing concern," the central bank said in its review.
"Overall, the Governing Council judges that the risks associated with high levels of household debt and a potential correction in the housing market are elevated and have not diminished since December."
Its concerns were partially echoed by Moody's Stephen Hess. The credit analyst told Reuters that housing prices could well fall months ahead, though he expects the impact to be relatively muted.
"It wouldn't be surprising if there was some correction in the housing market," Hess said.
"Will that cause a financial problem, system-wide? In the end we don't think that that risk is very great because of the lending standards that are in the banks, because the economy is still doing relatively well and employment is all right."
The Bank of Canada is at least partly responsible for both trends, having held its benchmark overnight interest rate at an ultra-low 1 percent.
But rates will have to rise at some point, one of the bank's deputy governors warned on Thursday.
"As we often remind households, it's important to realize that eventually interest rates are going to return levels that are closer to normal," Deputy Governor Agathe Cote said in a speech to a business audience in Montreal.
On a brighter note, the Bank of Canada's review suggested Canadians were beginning to heed the bank's advice. It said growth in household debt was slowing, though income growth was still failing to keep pace with debt accumulation.
The bank expects the household debt-to-income ratio to rise from the fourth quarter's 150.6 percent, a level that is already higher than in the United States and Britain.
In another report on Thursday, the government's housing agency said it saw the market cooling toward the end of 2012, even as the price of new homes continued to rise this spring.
Housing starts, which have been buoyant so far this year, will moderate later in 2012 and pull back slightly next year for the first time in four years, according to a quarterly report from the Canadian Mortgage and Housing Corp.
Canada should see 202,700 units started in 2012, dropping to 195,700 next year.
The housing market got a strong boost in the first few months of 2012 as a carry-over from 2011, when employment returned to pre-recession levels, Mathieu Laberge, deputy chief economist for CMHC, said in an interview.
"You have more people generating an income, therefore they go out and look for housing," he said.
The condominium markets in Toronto and Vancouver are of particular concern in the event of a slowdown, and fresh data shows no evidence that is happening yet.
Statistics Canada on Thursday said new housing prices in the combined area of Toronto and Oshawa, Ontario, had risen 0.3 percent in April from March, and 5.9 percent on the year. The figures were not broken down to show just the condominium portion in Toronto.
Vancouver overall saw no price gain on the month and a 0.8 percent decline from a year earlier.
For Canada as a whole, new housing prices edged up 0.2 percent from March and 2.5 percent on the year.
(Additional reporting by Rod Nickel in Winnipeg, Claire Sibonney and Andrea Hopkins in Toronto and Louise Egan in Ottawa; Editing by Frank McGurty)
This story was refiled to correct the spelling of first name of Moody's analyst to Steven from Stephen in the sixth paragraph of June 14 story