October 10, 2015 / 6:34 PM / 3 years ago

Bank of Canada: Rates are last line of defense on household debt

LIMA (Reuters) - Bank of Canada Governor Stephen Poloz acknowledged on Saturday that rising high household debt represented a key vulnerability of Canada’s financial system but said monetary policy should be the last line of defense in addressing it.

Bank of Canada Governor Stephen Poloz speaks during a news conference upon the release of the Monetary Policy Report in Ottawa, Canada July 15, 2015. REUTERS/Chris Wattie

The central bank chief said it was no surprise that low interest rates had caused people to take on more debt in the face of rising housing prices, as the low rates meant that the ratio of debt service to income was stable.

“I’m not trying to diminish the threat posed by elevated household debt. We are continuing to watch this closely. The point is that there is more to the story than the debt-to-income ratio,” he said in a speech on the sidelines of the annual meetings of the International Monetary Fund and World Bank.

Canada’s ratio of household debt to disposable income hit a record 164.6 percent in the second quarter.

Poloz’s remarks were among the last he would be making publicly before the Oct 21 rate decision. Most economists expect him to keep rates on hold, with the markets pricing in only a 9 percent chance of a cut. BOCWATCH

He justified his two rate cuts so far this year as required by the oil price crash cutting heavily into national income and threatening to drive inflation below target for an unacceptably long time.

“We knew that easing policy would have implications for financial stability. However, we also knew that those concerns had to remain subordinate to the primary mission of achieving our inflation target and getting our policy back in the zone where the risks are balanced,” he said in the prepared text of his speech.

The governor cited these two cuts as real-life examples of how the central bank would not let financial stability concerns pre-empt the inflation mandate if there were still macroprudential measures that could be taken first.

“Even in extreme conditions, when financial stability risks constrain monetary policy from achieving the inflation target over a reasonable time frame, a central bank would want to ensure that all macroprudential options were exhausted before trying to address those risks with monetary policy,” he said.

He also said that the cuts could actually lessen the chances of the oil price shock triggering financial stability risks, following an argument according to which the cuts will help avoid unemployment, for example, leading to potential defaults.

“In the current context, getting the economy back to full capacity with inflation on target is central to promoting financial stability over the longer term,” he said.

Nonetheless, he said the central bank reserved the right in general to opt for a policy path that aims to return inflation to target over a longer time frame than normal, in order not to significantly worsen financial stability concerns.

Among the lines of defense ahead of monetary policy, he said, are the global financial reforms in the wake of the recent financial crisis.

“What’s important now is that we finish the job. Ensuring the safety of the global financial system is in all of our interests. We can’t be distracted and lose sight of this objective,” he said.

Reporting by Randall Palmer; Editing by Chizu Nomiyama

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