The Bank of Canada said that U.S. trade policy under the Trump administration has “sharply reduced prospects for global economic growth” and warned that a long-term trade war will be Canada’s largest economic threat.
The central bank released its latest Financial Stability Report Thursday which found that while Canada’s financial picture had been “showing signs of increased health,” a U.S. trade war “increases risks to financial stability” and “poses the greatest threat to the Canadian economy.”
The report warned of heightened market “volatility and strains on liquidity” which could result in “market dysfunction” in the near future and a prolonged global trade war would result in “severe economic consequences.”
Such ramifications would prevent some households and businesses from maintaining their payments and would likely deter banks from issuing loans.
“If loan losses occur on a large enough scale, banks could cut back on lending in response,” said Bank of Canada governor Tiff Macklem in a press release. “This would exacerbate the economic downturn and put more pressure on businesses and households.”
Canadian households have been faring well over the last 12 months, carrying less debt relative to their income on average while insolvency filings by businesses are also down.
Debt levels may be lower than they were a year ago but they remain high by historical standards.
“Despite lower interest rates, signs of financial stress have risen over the past 12 months, particularly among households without a mortgage,” said Macklem. “For example, the share of these households that are behind on credit card or auto loan payments has continued to go up.”
Between this year and next, 60 per cent of households with a mortgage will face renewals and the majority of those are likely to see their payments increase, particularly if they took their mortgage out during the pandemic when rates were much lower.
There has been an overall improvement in Canada’s ratio of household debt to disposable income, which was 173 per cent at the end of last year, down slightly from 179 per cent at the end of 2023.
However, U.S. tariffs continue to create a very unstable economic scenario, one where Canadians will certainly fall behind on mortgage payments at levels not seen in a generation if they remain in place long-term.
Households or businesses in trade-sensitive industries or regions account for roughly 15 per cent of assets of banks in Canada and rippling effects of an economic slowdown would likely spread to a broader scope of industries and workers.
An extended trade war could potentially cause mortgage arrears to top 0.5 per cent, surpassing levels from the 2008-09 global financial crisis, noted the report.
Since the central bank’s previous report, “rates of arrears on credit cards and auto loans have risen further for households without a mortgage. After falling to historically low levels during the pandemic, these arrears rates are now back above their historical levels.”
While Macklem feels that Canadian banks are in a good enough position to absorb potentially higher losses, the uncertainty of the near future will require vigilance and caution.
“There are many uncertainties,” he said. “We still do not know what tariffs will remain, whether they’ll be reduced or escalated, or how long all of this will last. That makes it particularly difficult to anticipate the risks to the financial system.”