The possible dissolution of the North American Free Trade Agreement is the top downside risk for the Canadian economy, Bank of Canada Gov. Stephen Poloz said Thursday.
In an interview with CNBC from the World Economic Forum in Davos, Switzerland, Mr. Poloz said the termination of Nafta would be a net negative to the Canadian economy. It's unclear how the central bank would respond to such an event, he added, because there could be adjustments in foreign-exchange markets, such as a weaker Canadian dollar, and the Canadian government could provide fiscal stimulus to offer support.
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Roughly three-quarters of Canadian exports, or the equivalent of 20% of the country's gross domestic product, are U.S. bound.
Mr. Poloz said the uncertainty over Nafta -- with the latest round of talks under way in Montreal -- is already having an impact.
"Firms are telling us that they are holding off on investment," or considering investments in the U.S. versus Canada to hedge against the risk that the Trump administration terminates the agreement, he said. "Those kind of decisions last for a long time."
The Bank of Canada raised its main interest rate this month by a quarter-percentage point to 1.25%, its third increase in seven months, on the strength of stellar economic growth. However, it said it would henceforth move gradually on further rate increases due to the risk posed by the possible end of Nafta, which it added is having a drag on exports and capital spending.
President Donald Trump said this week that the current talks to address U.S. criticism of the 24-year-old trade pact are "moving along pretty well," but reiterated his threat to terminate the pact if negotiations don't address U.S. concerns about trade deficits.
In Montreal this week, the chief negotiators for Canada and Mexico have vowed to be flexible in trying to address the toughest U.S. demands, with a proposal coming as early as Thursday on the auto sector. But in a sign that Canada is already preparing for the possible end of Nafta, the country signed on this week to a Trans Pacific Partnership trade deal along with 10 other Pacific-rim countries. Canada had previously raised concerns about the TPP pact, thwarting an announcement in the fall of an agreement in principle.
Meanwhile, Mr. Poloz said the central bank is "feeling our way" when it comes to dealing with indebted Canadian households. He said the record level of consumer debt among Canadians means households are more sensitive to rate rises in the current environment than in the past.
Mr. Poloz said the central bank would carefully monitor the household response, adding there's been a "modest" slowdown in borrowing since the Bank of Canada started raising rates in July. On a 12-month basis, consumer borrowing climbed 5.6%, according to central bank data.
Mr. Poloz added the central bank wouldn't "actively comment" on the exchange rate, when asked about the impact of Treasury Secretary Steven Mnuchin remarks this week in Davos that a weaker U.S. dollar would be good for trade.
Write to Paul Vieira at email@example.com
(END) Dow Jones Newswires
January 25, 2018 08:15 ET (13:15 GMT)
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