December 10, 2014 / 5:43 PM / 3 years ago

UPDATE 1-Bank of Canada: steady financial risk despite overvalued housing

3 Min Read

(Adds risks and vulnerabilities; attention on commercial real estate)

By Randall Palmer and Leah Schnurr

OTTAWA, Dec 10 (Reuters) - Canadian housing may be overvalued by as much as 30 percent, but risks to the country's financial system remained steady with a stronger U.S. recovery expected to help keep Canada's economy out of trouble, the Bank of Canada said on Wednesday.

The central bank also said the recent slump in oil prices was not enough to trigger a severe recession that could lead to a sharp correction in housing prices.

The depreciation of the Canadian dollar that would come with lower oil would help offset the impact to the economy, it added in its latest semiannual Financial System Review.

"We judge that the probability of an adverse shock has eased since our June FSR," Governor Stephen Poloz said.

"This mitigates our observation that some financial vulnerabilities appear to be edging higher, leaving our overall assessment of financial stability risk roughly the same as in June."

The central bank did identify household financial stress and a sharp correction in house prices as the No. 1 risk, which it characterizes as elevated, though the probability of it materializing was low.

The bank estimated that the Canadian housing market, which did not go through the same correction that the United States did several years ago, is overvalued by 10 to 30 percent.

While this was similar to overvaluations in the past that preceded significant corrections in prices, in those cases interest rates were also rising to combat inflation, unlike the current situation where inflation is well anchored.

As well, the current housing market has been overvalued by 10 percent since at least 2007, the bank said.

"This supports the view that a soft landing is the most likely way forward," the bank's FSR said.

Poloz in a press conference also noted that the central bank is "well back from the front line" of defense for warding off housing instability, coming after prudence by consumers and banks, supervision by the bank regulator and regulations from the government.

Other risks the bank identified included the potential for a sharp rise in long-term interest rates globally as markets assess the future path of U.S. monetary policy, as well as financial stresses emanating from the euro area and China.

The bank also flagged the relatively high valuations and rapid increases in commercial real estate prices since 2009 as a vulnerability. (Editing by W Simon)

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