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Carney worried about Europe exposure

There is a reason why Canada's top money man -- Mark Carney -- is worried about the country's exposure to the euro zone crisis, even though the financial services sector's direct exposure is minimal.

Only 3.4 percent of the tier-1 capital by Canada's biggest banks is tied to Italian bonds. That compares to 154 percent for Germany's banks and almost 200 percent for banks in France.

The government of Canada hasn't had a problem selling sovereign debt, according to the Bank of Canada. Governor Carney says demand remains steady because of the world perception that our credit is higher quality than most other countries. But Carney points out that risks to the stability of Canada's financial system are high and have increased "markedly." That's because the euro zone could slow global growth.

Here's what Carney fears if that's the case: First, it would make things worse for sovereign debt holders and issuers, which would taint the quality of bank loan portfolios. With the world's economy slowing, Canadians could be hit as companies tighten the purse strings, yet again.

Part of that last point is tied to the United States -- our biggest export customer. It's not just because of the euro zone, but America's own debt crisis. Carney points out that there's a small but significant risk that if a divided Congress can't come together to tame the U.S. budget deficit, investors could lose faith in Washington and start demanding more in return for lending it cash. What Carney's concerned about is the pendulum swinging too far the other way: tightening belts and putting a crimp in imports of Canadian products along the way.

That wouldn't be so much of a problem if we weren't spending $1.49 on every dollar's worth of pre-tax income --a near record high and expected to climb. Carney has been beating the household debt drum for a year now and if the euro zone crisis expands, an unemployed Canadian is a Canadian not servicing their debts.

TD Economics is telling clients today "the shock will be mild enough to avoid a household deleveraging, but will certainly constrain household expenditures."

TD believes the European financial crisis will likely worsen as we start 2012 and ease up by the summer. But it's warning global growth will slow further and the risks will continue to increase. As a result, the bank is reminding us that the Bank of Canada is unlikely to raise interest rates in this environment -- but unless Canada slides back into recession, it's not predicting rate cuts, either.

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