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Canadian Financial System Robust But Highly Susceptible to Euro Crisis

By Tzu-Wen Chen
14 June 2012 15:09 GMT

THE TAKEAWAY: [Bank of Canada’s Financial System Review released] > [High risks to Canadian economy if euro crisis worsens] > [USDCAD little changed]

In its semi-annual Financial System Review released today, the Bank of Canada (BoC) cited continued robustness of Canada’s financial system and relative stability in domestic credit markets despite the fragile global environment. However, the Bank warned of high dangers to the Canadian economy if the European sovereign debt crisis worsens, emphasizing that worsening conditions in the euro zone could cause “major shock” to Canada.

The sources of major risks to the stability of Canada’s financial system remain broadly the same as those reported in the December 2011 Review, as outlined below:

  • Further escalation of the euro-area sovereign debt crisis;
  • An economic slowdown in other advanced economies;
  • Financial stress in the Canadian household sector;
  • A disorderly resolution of global current account imbalances; and
  • Excessive risk-taking associated with a prolonged period of low interest rates.

Should the euro debt crisis continue to intensify, further weakening in global economic would fuel sovereign fiscal strains and heighten risk aversion. This would exacerbate pressures on bank balance sheets and ensuing tightening of lending conditions would further dampen global economic growth. Diminished growth prospects would foster expectations of continued low interest rates, possibly eroding the financial positions of life insurance companies and pension plans while boosting household borrowing in Canada.

The Bank stated that mitigation of risks to the global financial system requires a number of policy actions, with containment measures in the euro area at the forefront of priorities. Mitigation measures abroad include adequately capitalizing euro-area banks, reinforcing financial firewalls, enforcement of structural and product market reforms, and a clearer path for risk mutualization within the European monetary union. Globally, current account imbalances must be addressed to help foster sustainable and balanced global economic growth.

Domestically, “the high indebtedness of the household sector and elevated valuations in the housing market require continued vigilance”. In regards to broader financial reform, Canadian banks plan to implement Basel III capital rules as a key priority, which will help build a resilient market infrastructure in future.

USDCAD 1-minute Chart: June 14, 2012

Canadian_Financial_System_Robust_But_Highly_Susceptible_to_Euro_Crisis__body_Picture_1.png, Canadian Financial System Robust But Highly Susceptible to Euro Crisis

Chart created using Market Scope – Prepared by Tzu-Wen Chen

The loonie remained largely unchanged against the greenback, as few developments have come out since the Bank’s December 2011 Review. At the time of this report, the USDCAD pair was trading at C$1.0246 to the dollar.

--- Written by Tzu-Wen Chen, DailyFX Research

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14 June 2012 15:09 GMT