How deeper euro crisis would whack Canada

These are stories Report on Business is following Thursday, June 14, 2012.

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Bank of Canada warns on Europe
The Bank of Canada today issued a particularly harsh warning about the potential impact of a deeper euro crisis on Canadian banks and the broader economy.

As The Globe and Mail's Jeremy Torobin reports, Governor Mark Carney and his colleagues also highlighted how consumer debt is still the biggest domestic threat, while they also spelled out their concerns about the Toronto condo market.

In their semi-annual review of the financial system, they underscored how troublesome the crisis in the 17-nation monetary union could become. I've cherry-picked from today's report:

"If the sovereign debt crisis in Europe continues to intensify, it would further weaken global economic growth and prompt a general retrenchment from risk. In turn, the weaker global outlook would fuel sovereign fiscal strains and impair the credit quality of bank loan portfolios. The rise in risk aversion would exacerbate pressures on bank balance sheets and could prompt a tightening in lending conditions to households and businesses, adding to the drag on global economic growth. Together, these factors would increase the probability of an adverse shock to the income or wealth of Canadian households. Diminished prospects for growth would also foster expectations of continued low interest rates, potentially further eroding the financial positions of life insurance companies and defined benefit pension plans, and boosting household borrowing in Canada."

"The risk is that these pockets of stress could intensify further and spread across Europe. If that were to occur, the spillover effects to Canadian financial institutions would be substantial, in the form of higher funding costs and higher markdowns on direct and indirect exposures to the affected economies. In addition, such an event would have a major adverse impact on the Canadian economy, which would lead to increased losses on domestic loans."

"To date, there have been limited writedowns by banks, and the provision of credit to households and businesses in Canada has not been affected. However, should the crisis worsen and spread further across Europe, the impact on the Canadian financial system could be significant. This could come about through three interrelated channels. First, a decline in confidence would lead to a general retrenchment from risk and push up the cost of, and/or curtail the availability of, wholesale funding for financial institutions. This would prompt a tightening of lending conditions by the affected institutions. Second, Canadian financial institutions would incur losses as they mark down their holdings of assets that are affected by direct and indirect exposures to stressed European entities. The indirect impacts could become especially important if entities in the United States were significantly affected by the crisis. Third, heightened stress in global sovereign debt markets would weaken economic activity - both abroad and domestically - and increase non-performing loans at banks. The combined effect of these events could constitute a major shock for both the Canadian financial system and the economy as a whole."

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Crisis deepens
What a mess.

Here's what the euro zone looks like today as it heads to its do-or-die moment with the weekend elections in Greece:

• Yields on Spain's 10-year bonds spiked to what is deemed the unsustainable level of 7 per cent, the point that forced other countries into a bailout.
• Italy's borrowing costs also surged at a widely watched auction.
• The Swiss National Bank, which has been trying to come to grips with a soaring currency as money flows out of troubled countries into Switzerland, warned of the possibility of capital controls if it has to go that route. "The SNB will not tolerate this," warned its chief Thomas Jordan. "If necessary it stands ready to take further measures at any time."
• Everyone is fighting with everyone else as finger-pointing becomes the norm. Spain's foreign minister, for example, warned in a radio interview that Germany must not throw "one country to the wolves."
• In Berlin, German Chancellor Angela Merkel noted that the debt crisis will overshadow next week's G20 summit in Mexico, but she warned against potential solutions that appear easy. Ms. Merkel is opposed to several measures proposed by others, such as euro bonds or a method to share the risk of ailing banks.
• Tensions continue to run high in Greece, where this weekend's elections could determine whether Athens remains in the monetary union. There are suggestions that the pro-austerity forces are ahead, which is what investors want to see.

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The anxiety in the euro zone has reached a new level after the downgrade of Spanish debt late yesterday Moody's Investor Service in the wake of the agreement to bail out its banks, which will put more pressure on the government's own finances. That, in turn, has sparked speculation that another bailout will be needed.

"The rout in Spanish bonds continues relentlessly, as Madrid?s borrowing costs move ever higher and ever closer to the dangerous 7-per-cent level," said market analyst Chris Beauchamp of IG Index in London.

"The Spanish bank rescue was a flop by Monday afternoon, and now it's turning from tragedy to something akin to farce. Moody?s stuck the boot in late last night, downgrading Spain?s sovereign debt rating to just one notch above junk level, and expectations are building that Madrid will need yet more cash in the near future."

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Whither the G20?
Is next week's G20 summit in Mexico already shaping up to be a failure?

While the world is looking its leaders to get the global economy out of its funk, divisions and tensions show no signs of easing. As noted above, Germany's Angela Merkel doesn't appear to be willing to bend on issues related to the euro zone. Nor does Stephen Harper.

The biggest issue, of course, is the financial crisis in the euro zone, which shows no signs of easing. And Greece's weekend elections will determine whether it gets better or worse.

As Andrew Kenningham of Capital Economics sees it, there are three things the G20 can do:

• Boost the ammunition of the International Monetary Fund, which has largely been put together, though Canada rejects pumping money in to help bail out Europe.
• Take co-ordinated stimulus measures.
• Twist Germany's arm to bend on proposals such as issuing euro bonds or striking a so-called banking union.

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"Apart from confirmation of a substantial increase in resources for the IMF, which was already agreed earlier this year, we doubt the meeting will achieve much," said Mr. Kenningham, the group's global economist in London.

So far, other countries have agreed to more than $430-billion for the IMF, though Canada is an outsider. Coupled with Europe's bailout fund, Mr. Kenningham noted, the combined lending power will top ?1-trillion.

"It would be sufficient to finance a fully-fledged sovereign bail-out for either Spain or Italy, as it would require around ?500-billion and ?700-billion respectively to take these countries out of the market for a three-year period," he said.

"However, it would not be enough to finance bailouts for both Spain and Italy unless the IMF were willing to shoulder a much larger share of the burden than it has in previous bailouts - something which the IMF?s key shareholders would not sanction. What?s more, it is clear that the euro zone crisis cannot be resolved by bailouts alone, however large the sums involved."

Mr. Kenningham does not expect co-ordinated action from major central banks.

Nor do observers expect Ms. Merkel to bow from G20 leaders to take a "far more decisive and radical approach" to the crisis, which she, indeed, signalled today.

"German Chancellor Angela Merkel has pushed back against her critics in Europe and the G20, saying that it can?t be left to Germany alone to sort out the problems in Europe," said senior analyst Michael Hewson of CMC Markets. "This defence suggests that she remains in no mood to budge on her stance that there will be no movement on debt mutualization. "

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Payday for Lazaridis, Balsillie
Mike Lazaridis and Jim Balsillie, who built Research In Motion Ltd. into a global smartphone giant before presiding over the company?s long slide, will receive a payout of around $12-million after having stepped aside as co-chief executive officers in January, The Globe and Mail's Iain Marlow reports today.

Noting that Mr. Lazaridis and Mr. Balsillie ?revolutionized the worldwide wireless industry with the introduction of the BlackBerry and forever changed how the world communicates,? the company said in a management circular that it had entered into transition agreements with the two executives.

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Nokia slashes
Nokia Corp. is cutting deep, with plans to slash 10,000 jobs by the end of next year and shut down several facilities, including one in Burnaby, B.C.

The embattled phone manufacturer said today it will shut down research and development operations in Burnaby and Ulm, Germany, and a manufacturing plant in Salo, Finland.

"We are increasing our focus on the products and services that our consumers value most while continuing to invest in the innovation that has always defined Nokia," said chief executive officer Stephen Elop. "We intend to pursue an even more focused effort on Lumia, continued innovation around our feature phones, while placing increased emphasis on our location-based services. However, we must re-shape our operating model and ensure that we create a structure that can support our competitive ambitions."

Nokia also unveiled a round of executive changes, and said it expects a further charge of about ?1-billion in connection with the restructuring, adding to others already announced.

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CMHC sees moderation
Canada Mortgage and Housing Corp. projects moderation this year in both the market for both new and resale homes.

In a new forecast today, the agency said it expects housing starts of about 203,000 this year, and almost 196,000 in 2013.

Sales of existing homes are projected to be about 472,300 in 2012 and 474,900 next year.

As for prices, CMHC projected a national average of $372,700 for this year and $383,600 for 2013, increases of 2 per cent and 3 per cent that it said are consistent with "balanced markets conditions" expected to continue.

"Housing has gained some momentum recently," said deputy chief economist Mathieu Laberge.

"Housing starts in the early part of the year were robust due to the multiples segment, which varies significantly from month to month. Although economic conditions are expected to remain supportive of housing demand, housing starts activity is expected to moderate as 2012 progresses. Similarly, balanced market conditions in the existing home market will result in modest house price gains through to the end of the year."

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U.S. consumer prices dip
Consumer prices in the United States fell on a monthly basis in May for the first time in two years, and the outlook is one that would ring no alarm bells for the Federal Reserve.

Prices slipped 0.3 per cent in May, bringing the annual pace of inflation down to 1.7 per cent, largely as prices fell at the gas pump.

So-called core prices, however, which strip out volatile items, held steady at 2.3 per cent.

"Energy, and specifically gasoline, was the main factor driving prices lower, and with oil and pump prices falling further subsequently will likely keep inflationary pressures muted over the next couple of months as well," said economist Andrew Grantham at CIBC World Markets.

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