An escalation of trade tensions with the U.S. or Canada’s exclusion from a renegotiated NAFTA would increase risk for Canadian banks amid a slowing mortgage market and rising interest rates, potentially exacerbating the debt-service burdens of highly levered households, New York-based Fitch Ratings says in a report published Tuesday.
The ratings agency’s base case is that NAFTA will be successfully renegotiated, however, asnegotiations drag on “a full abrogation, interim tariffs or prolonged uncertainty relating to bilateral discussions with the U.S. remain a major tail risk for Canada,” Fitch says in the report.
Additional tariffs would be felt throughout the economy, Fitch says, adding that this would weaken labour and housing markets, and reduce investor confidence.
“Downside economic risks from tariff-related job losses could also translate into higher losses in bank consumer portfolios,” the report warns.
Canadian bank earnings are highly correlated to gross domestic product (GDP), the report notes.
“In a scenario where the U.S. imposes auto import tariffs at 25% and additional tariffs on China, with trading partners retaliating symmetrically and a NAFTA collapse, Canada’s GDP would be cut by 0.8 percentage points in 2019 and 0.2 percentage points in 2020, the report says.
The impact could be enough to cause the Bank of Canada to pause raising rates, or even to cut rates, it adds.
Nevertheless, the capital levels at the six major Canadian banks “appear sufficient to absorb the potential downside shocks,” the report says.