Europe debt drama costly

Canada is paying a heavy price for Europe’s unresolved debt crisis, the Bank of Canada said Wednesday, estimating the loss to economic output this year at 0.6 per cent, or about $10 billion.

OTTAWA — Canada is paying a heavy price for Europe’s unresolved debt crisis, the Bank of Canada said Wednesday, estimating the loss to economic output this year at 0.6 per cent, or about $10 billion.

The costs to the global and American economies are even greater, at more than one per cent of gross domestic product and 0.8 per cent respectively.

The calculation marks the first time the Bank of Canada has attempted to put a hard number on the spillover effects of the ongoing European sovereign debt drama, and it shows the Canadian and global realities would be materially different, but for Europe.

The bank estimates that Canada’s economy would be worth about $10 billion more at the end of the year, with the subsequent beneficial impact on everything from more jobs, higher incomes and corporate profits and better government fiscal positions.

“Thus far, the impact on global financial conditions from the strains in Europe has consisted mostly of a general retrenchment from risk taking,” the Bank of Canada policy council, headed by governor Mark Carney, states in its latest quarterly outlook.

“Over the projection period, the impact is expected to become more widespread, however, and to take the form of increased funding pressures, adverse confidence effects and reduced availability of credit. In particular, deteriorating funding conditions are projected to push banks to restrict access to credit for households and businesses in Europe and the United States, adding to the drag on economic growth.”

The impact on Canada is less than on the U.S. and the world generally, because of the limited banking exposure to both European banks and sovereign debt and because Canada’s financial institutions remain sound and in a position to lend.

But the central bank notes that Canada will still be hit through indirect channels in terms of general financial conditions, consumer and business confidence and lower global commodity prices — a main component of trading on Canada’s financial markets.

Europe is, of course, paying the biggest cost. The bank said it now expects the eurozone countries to be in recession for the next four months.

Global growth is also slowing down to a likely 2.9 per cent pace this year, the bank said, although its view is rosier than the World Bank’s 2.5 per cent expectation.

On Tuesday, Finance Minister Jim Flaherty again expressed frustration that European leaders have so far failed to put in place the policy measures that would ensure the debt contagion does not spread to global credit markets. Analysts say if that happens, the aftermath would be similar to the Lehman Brothers collapse in the fall of 2008 — a freeze in credit in many advanced countries, possibly triggering a second global recession.

“We’ve been watching this European situation and participating in the discussions for a full two years now and there’s still not resolution. This poses a danger for the U.S. economy, the U.S. banking system, and our economy as well,” Flaherty said.

The Bank of Canada makes clear in its latest Monetary Policy Review that it considers the risks of European financial flu spreading to be increasing rather than diminishing.

It is the main reason the bank has downgraded growth rates slightly for the next four quarters — starting this month — from its previous projection in October.

For the year as a whole, the bank reported on Tuesday that growth would average two per cent.

Although the 2012 average growth is one notch higher than previously anticipated, that is only because the last half of 2011 turned out significantly stronger than previously expected, meaning the economy is beginning the year from a higher vantage point.

“The bank continues to expect these (external) headwinds will limit economic growth in Canada in 2012 to a modest pace, after which growth is projected to pick up as the global environment improves,” it said.

Overall, the economy is unlikely to return to full capacity until the third quarter of 2013.

But the bank also cautions that its assumptions are based on Europe being able to keep the crisis from escalating, a hope for which it admits its confidence is being tested.

On Tuesday, the bank conceded its low interest rate policy is encouraging more Canadians to take on greater debt, particularly to purchase homes.

But the policy review document points out that there is an upside to the sky-high household debt levels it fears. As weak as the economy is, it is because of the strong household market and consumers continuing to purchase everything from clothes to cars and homes that the economy is not doing even worse. Housing and consumption account for 70 per cent of this year’s growth.

“Residential investment is … now expected to remain strong, owing to its greater-than-anticipated momentum in the second half of last year and favourable mortgage financing conditions,” the bank said.

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