Bank of Canada says economy 'vulnerable'

Canada's banking system did well through the market turmoil in May but is "vulnerable to renewed stress" if global markets are roiled again by concerns about a possible economic slowdownor defaults on national debts, the Bank of Canada warned Monday.

The central bank's governing council, in its semi-annual financial system review, said the risks to financial stability increased over the past six months and could affect domestic banks and other financial institutions as concerns over national debts cause bond markets to hike lending costs.

The bank said the financial system will remain "fragile"until countries agree to reforms to reduce excessive risk-taking by banks and reduce national debts.

It said the risks associated with currency swings, the possibility of a global economic slowdown and more turmoil on financial markets have all increased over the last six months.

"Despite forceful policy actions to stabilize the global financial system since 2007, several of the vulnerabilities that contributed to the crisis remain, and, in some cases, may have been exacerbated."

Last week, bank governor Mark Carney said interest rate increases are not a certainty in the face of mounting concerns about the strength of the recovery.

The bank also flagged concerns about the rapid growth of Canadians' personal debt through the recession.

"The proportion of Canadian households that are judged to be vulnerable to adverse wealth and income shocks has increased in recent years with the steady rise in aggregate household debt in relation to income,"the banksaid.

The bank likely wants to increase rates, in part to head off an increase in household debt, Todd Hirsch, senior economist with ATB Financial, told CBC News. But it must also watch the market turmoil in the rest of the world to avoid increasing rates in case global recovery slows.

"It's a very delicate balancing game [Carney is] playing right now and the bank has been saying maybe now more than at any other point in history, 'We don't know how all this is going to play out so we can't give much guidance on where those rates are going in the short term.'"