Flaherty worries Europe’s debt is contagious

There is still “a real danger” of contagion from the ongoing sovereign debt crises in Europe, including the possibility of some damage to Canada’s banking system, federal Finance Minister Jim Flaherty said Monday.

TORONTO — There is still “a real danger” of contagion from the ongoing sovereign debt crises in Europe, including the possibility of some damage to Canada’s banking system, federal Finance Minister Jim Flaherty said Monday.

“Canada is not an island — no country, any more, is an island — our economies are clearly interrelated,” Flaherty said at a breakfast appearance in Toronto following weekend discussions with other G7 countries about the risks associated with Europe’s debt crisis and the best way to contain it.

Worries over the crisis are keeping investors on edge following a warning over Italy’s credit rating and a failure by eurozone finance ministers to agree on an immediate release of bailout funds to Greece.

Concern about rising government debt and deficits is sending jitters through bond markets around the world.

If Greece is forced to default on some of its debt, investors could lose faith in other eurozone countries and even question investing in overseas bonds in the United States and Canada.

In the short-term, Canada’s bond market may benefit as investors seek out relative safe havens. But the crisis could also negatively impact the Canadian stock market and drive commodity prices down as investors become less tolerant of risk and worry the growing debt crisis could weaken the global economic recovery.

Canadian banks — which invest in Eurozone bonds — have been ranked as some of the most financially sound in the world. But even they are not immune to the possibility of Greece’s debt crisis spreading beyond its borders, Flaherty said.

“There is substantial concern,” he said, adding he hopes European countries can swiftly bring in a second bailout package for Greece because any delay could result in additional strife.

“Delay is not desirable. It’s important to come to a resolution to avoid the danger of contagion arising out of the situation in Greece,” he said.

“We know that delay causes more difficulties, makes the situation more expensive and creates more strife at the end of the day.”

The global financial crisis of 2008, triggered by U.S. banks’ exposure to risky real estate lending, is a cautionary tale about the far-reaching impact of events in one region, said Colin Cieszynski, a market analyst at CMC Markets Canada.

“There’s the possibility of general global lending slowing down. It’s something that the European Union and the IMF have been fighting like crazy to try and keep this from happening again because everyone saw what happened last time,” he said.

The region’s finance ministers have signed off on important changes to their bailout funds, which they hope will reinforce confidence in the eurozone’s struggling economies even though the Greek crisis is at a new boiling point.

As Greece risks defaulting on its debt next month, market pressure was increasing on countries like Portugal, where borrowing rates hit record highs Monday.

Eurozone finance ministers said they would only hand over Greece’s next bailout instalment — worth C12 billion (US$17 billion) — on condition the Greek Parliament backs further austerity measures.

Flaherty said he’s been involved in several G7 telephone conferences related to European debt not just in the past few days, but in the months since the issue first began to surface.

“The desire, of course, is to ensure that there is resolution on the situation in Greece,” he said.

Meanwhile, Flaherty said any shock to Canada would be relatively minor if Greece defaulted.

“Having said that … there can be a contagion effect which can create difficulties in the banking system — which is not desirable.”

Flaherty added that he’s optimistic that the situation will be resolved.

Other global concerns that could impact Canada’s economic performance include continuing weakness in the U.S. housing market, Flaherty said. However, he added that the IMF and others still predict the U.S. economy will grow at a moderate pace over the rest of the year.

Flaherty said he was not concerned about the Canadian housing market despite sky high prices in “hot spots” like Vancouver and has no intention of implementing new measures to put the brakes on the market.

Flaherty has introduced such measures three times in the past three years.

“There’s some moderation in the market, which is a healthy thing,” he said.