Watch that debt!

Canadians are putting themselves and the financial system at a risk by taking on too much debt, the Bank of Canada warns, even as signs point to an economy on the mend.

OTTAWA — Canadians are putting themselves and the financial system at a risk by taking on too much debt, the Bank of Canada warns, even as signs point to an economy on the mend.

The central bank expressed the worry — not for the first time — in its semi-annual financial sector review Thursday, stressing that Canadians continue to take on record-high levels of debt.

It says the amount of debt Canadians have taken on is now 142 per cent more than income, a record high.

Speaking the reporters, Finance Minister Jim Flaherty agreed that record-low interest rates have lured Canadians into the housing market and left them vulnerable to a change of fortune.

“We certainly want people to be careful and there’s lots of money being lent, and I do ask Canadians to be mindful of the fact that interest rates will not be low indefinitely,” he warned.

The fear is that with Canadians continuing to snap up houses, they won’t be able to afford to pay their mortgages once rates increase.

As well, many Canadians have used equity in their homes to take out loans to spend on other consumer goods, raising their risk exposure in a downturn.

Unlike many other sectors, Canada’s housing market has fully recovered from the recession, with both sales and prices up by about five per cent since the previous peak in 2007.

The central bank says the percentage of households where interest payments exceed 40 per cent of income — making them vulnerable to default — could increase to near 10 per cent by 2012 under certain interest rate assumptions. That’s well above the 6.1 per cent average of the last 10 years.

In the past year, income growth has averaged about two per cent, but consumer credit has been rising at seven and eight per cent, said Bank of Montreal economist Douglas Porter.

“Household debt as a share of income has risen solidly, so I think it is a medium-term risk to the economy,” he said.

“If and when the day comes when the Bank of Canada has to raise rates, it could push a lot of people into difficulties very quickly.”

The central bank cautions, however, that its risk assessment is not meant to be a prediction, only an early warning system of potential dangers.

Those dangers would become more likely if the economy undergoes a second downturn, which the bank says is unlikely, but not impossible.

The prospects of a second slump diminished somewhat, however, with two reports Thursday in Canada and the U.S. showing international trade — a major indicator for the export-heavy Canadian economy — on the upswing.

Canadian exports confounded forecasters by rising 3.4 per cent in October, enabling the country to post the first trade surplus in four months.

U.S. trade also came in stronger than expected, with exports rising more than 2.5 per cent in each of the last two months.

”Broadly speaking we see world trade is on the path to recovery (and) that’s definitely good news for Canada,“ said CIBC economist Meny Grauman.

But Grauman cautioned that the strong Canadian dollar and the tepid growth projected for the U.S. next year remains major stumbling blocks for Canadian exporters. Even though exports bounced back in October, they remain 26 per cent below where they were a year ago.

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