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* Bank sees lower overall risk to financial stability
* Says household debt, housing imbalance biggest weaknesses
* Says data suggest household market overvalued
By Louise Egan
OTTAWA, Dec 10 (Reuters) - Soaring consumer debt and a robust housing market pose an "elevated" risk to Canada's financial stability, but the overall level of danger has fallen from six months ago, the Bank of Canada said on Tuesday.
"In Canada, the high level of household debt and imbalances in the housing sector are the most significant domestic vulnerabilities to address," the central bank said in its semi-annual Financial System Review.
These risks could make Canadians vulnerable to an adverse macroeconomic shock and a sharp correction in the housing market, it said.
The bank cut its overall level of risk to the country's financial system to "elevated" from "high", citing among other factors continuing stabilization in the euro zone and the start of a modest recovery in that region. Despite the brighter outlook for Europe, it remains the biggest threat to Canada, the bank said.
Tuesday's report marked the first time the bank has eased its overall risk level since it began classifying risk in this way in December 2011.
The overall level of risk could fall further with continued progress on banking sector reform and other reforms in the euro area. That said, the level could increase if the current low interest rate environment in advanced economies persists longer than anticipated, it added.
The bank listed risky financial investments in a prolonged period of low interest rates as a "moderate" risk and added financial vulnerabilities in emerging markets as another moderate threat.
Canada's housing market has been a source of concern for policymakers and economists since a property boom helped fuel the economy's rebound from the 2008-09 recession.
After four government interventions to tighten mortgage rules, the market cooled in late 2012 only to regain momentum through the spring and summer of this year.
The bank, the finance ministry and the banking regulator monitor the market closely. The bank noted an oversupply of multiple-unit dwellings in some areas, and cited an elevated number of high-rise condos under construction in Toronto.
"If the upcoming supply of units is not absorbed by demand as units are completed over the next few years, there is a risk of a correction in prices and construction activity," it said.
Such a correction could spread to other parts of the market and hit the overall economy, it added.
The bank said simple indicators suggest there is overvaluation in the housing market overall and it said any sharp downturn in a large city could spread, ultimately affecting sentiment, lending conditions as well as jobs and income.
While the latest data suggest some stabilization in the market, there is still much debate among economists over whether housing is poised to crash and damage the economy, or have a so-called "soft landing".
Bank of Canada Governor Stephen Poloz has placed himself in the latter camp, saying he expects record-high household debt to ease gradually as the housing market softens.
The report on Tuesday supported that view.
"The overall moderating trend is expected to resume in due course," it said. "As long term interest rates normalize with the strengthening global economy, the risk will diminish over time."
The ratio of household debt to income in Canada hit a record high in the second quarter of 163.4 percent, although the pace of credit growth has been slowing.
Statistics Canada will release third-quarter data on household debt on Friday.