Prior to the onset of the trade war ushered in by the United States, the economic situation of Canadian households and companies was noticeably gaining momentum, a trend noted by the Bank of Canada. As the year unfolded, it was observed that debt-levels in relation to income were lesser than the previous year, indicating a healthier financial position for both individuals and corporations. Additionally, businesses were demonstrating a declining number of insolvency filings, which further signaled the strengthening of the country’s economic climate.
Despite the improving financial scenario, a new challenge has arisen which threatens this positive trajectory. The looming trade war instigated by the U.S. has seemingly increased risk factors across the board, clouding the previously bright outlook. With the advent of the trade war, the resultant uncertainties and potential risks warrant that individuals and enterprises turn their attention to preparing for the anticipated turbulence to come.
The uncertainty that hangs over the future trajectory of tariffs is vast, albeit if they were to spike and remain high for a prolonged period. Under such conditions, the Bank of Canada fears that Canadians might begin to witness rising instances of mortgage defaults at rates not experienced in recent history.
Should the trade war prolong, the greatest fear is that this could become the most profound threat facing the Canadian economy. Framed in a more severe scenario – although not a prediction, the Bank of Canada cautions that an extended trade war could potentially tip mortgage arrears beyond the 0.5% mark, exceeding levels observed during the worldwide financial crisis of 2008-09. While lower than the over 0.6% experienced in the 90s, it is a significant concern.
While government interventions could potentially alleviate some of the impact, determining the extent and generosity of such assistance remains an uncertainty. In an added effort to evaluate the resilience of Canada’s financial system, a more drastic stress-test situation proposed by the International Monetary Fund (IMF) was included in the bank’s assessment.
Contrasted to the Bank of Canada’s risk scenario projecting a recession lasting a year— on par with previous recessions in 2008-09 and 1990-91, the IMF painted a direr picture spanning seven quarters. In this grim landscape, GDP could potentially dive by 5.1%, unemployment peaking at 9.2%, house prices plummeting by 26%, and a 36% decline in stock prices from their peak values.
The report further cautions that the adverse consequences of the trade war wouldn’t instantly disappear with its cessation. Permanent repercussions are anticipated due to the loss of trust in the international economic environment.
The reported risk scenarios paint stark contrast to the brighter economic outlook featured at the beginning of the year. The Bank of Canada points to a softened impact from the recent spike in mortgage renewals compared to the estimates made at the close of 2023 due to increased income and housing price benefits received by homeowners.
Non-financial enterprises have managed to retain their financial strength thanks in part to lower interest rates, serving to enhance business resilience and support those with mortgages. However, households without mortgages continue to display rising signals of economic burden.
The report indicated that non-mortgage households have witnessed an increase in delinquency rates over 60 days for both auto loans and credits cards, which now surpass the pre-pandemic rates and have exceeded the historical average.
Contrarily, households with mortgages have managed to keep payment arrears well beneath historical averages. However, Canadians, in general, continue to shoulder a debt burden significantly higher than past norms. This exposes them to heightened risk should the trade war persist, particularly those entities more vulnerable to the imposition of tariffs.
According to estimations from the Bank of Canada, loans given to businesses and households in industries or regions sensitive to global trade make up approximately 15% of Canadian banks’ assets. There’s concern that an economic slowdown could have cascading effects impacting a more extensive range of sectors and employees.
Canadian banks, however, remain well-equipped to weather potential shocks owing to their robust capital buffers and provisions for credit losses. While the trade war has added an element of uncertainty to the global economic landscape, the Bank of Canada maintains optimism that the Canadian financial institutions have the mechanisms to rapidly adapt and manage the risks.