Managing Canada’s Recovery

As Canadian policy makers assess the ongoing economic recovery, they remain cognizant of the risks of returning to a tightening stance. Among them are the risks of attracting increased foreign capital inflows, which would drive the Canadian dollar to new highs, exacerbating the country’s competitiveness woes.

Regulators are set to employ other policy tools to avoid exacerbating the deterioration of household finances. As we pointed in our recent 2011 Outlook, the government is likely to turn to regulatory means to reign in credit practices to avoid over-lending to the property sector, rather than just using the interest rate. Press reports suggest this could come as early as today (January 17). Based on the relative success of the tightening of the mortgage-lending requirements announced by Canada’s Department of Finance in 2010, regulators may chose to continue along the same lines, addressing rules for home-equity loans, or again decreasing the maximum mortgage amortization period, and reducing government support. Press reports suggest that the government will reduce amortization rates to 30 years and cut government support from housing-backed lines of credit. While these measures are not likely to lead to a major correction, they could exacerbate the general softening of the housing market. The banks are now on the alert, both regarding their loan books and the Bank of Canada’s worries, and we expect credit growth to become more muted.

Canada’s challenge is to continue to let the wind slowly out of the sales, while not leaving the fragile recovery in the doldrums. Should oil prices continue to climb well above their current level, or should Canadian and U.S. demand surprise on the upside, the correct balance will be harder to strike.

Editor’s Note: This post is excerpted from a much longer analysis available exclusively to RGE Clients: North America Focus: Will Consumer Spending Hold Up in the U.S. and Canada?