December 2, 2015 / 3:21 PM / 3 years ago

UPDATE 2-Bank of Canada holds rates steady, but flags household debt risk

* Overnight rate remains at 0.5 pct

* Canadian dollar firms

* Analysts do not expect rate hike until Q1 2017 (Updates throughout with analyst quotes, market reaction, growth outlook, bylines)

By Randall Palmer and Leah Schnurr

OTTAWA, Dec 2 (Reuters) - The Bank of Canada held interest rates steady as expected on Wednesday, but warned of rising vulnerabilities in the household sector, where debt levels have climbed as consumers take advantage of low borrowing costs.

The Canadian dollar firmed following the central bank’s policy statement, which was seen by some market players as less dovish than expected given news this week that the economy shrank in September.

“There were some who thought the bank would sound a bit more downbeat on the outlook,” said Doug Porter, chief economist at BMO Capital Markets.

The bank kept its overnight interest rate at 0.5 percent, noting that Canadian and global growth is evolving broadly in line with its October outlook.

While warning that vulnerabilities in the household sector continue to edge higher, it said overall risks to financial stability are evolving as expected.

The most recent reading of Canadian household debt relative to income was at a record high, as the housing market continues to rise in Toronto and Vancouver.

Some critics have said the bank is spurring Canadians to take on more debt than they can carry, especially once rates rise.

The central bank, which cut rates twice this year as the economy was hit by cheap oil prices, has said there was a greater risk in not acting to support the economy.

Analysts expect no interest rate move from the bank until a hike in the first quarter of 2017, even as many expect the U.S. Federal Reserve to tighten policy this month. The Bank of Canada said on Wednesday monetary policy divergence was expected to remain a prominent theme.

That remark “is a pretty robust indication that the bank has zero intention of raising rates any time soon, even as the Fed begins hiking,” said Porter.

Following the statement, traders trimmed the already low odds of another Canadian interest rate cut in January.

Canada was in a mild recession in the first half of 2015. Growth rebounded in the third-quarter but September was disappointing, suggesting a softer transition to the final quarter.

The bank said it expects fourth-quarter growth to moderate from the previous quarter but rise to above potential next year, in line with October’s forecast.

The bank shrugged off slightly higher bond yields in Canada, saying that financial conditions remain accommodative. It said Canada’s “complex and lengthy adjustment” was being aided by the U.S. recovery, lower loonie, and the bank’s rate cuts.

Additional reporting by Andrea Hopkins in Toronto; Editing by Jeffrey Hodgson and Frances Kerry

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