The Bank of England has issued a stark warning this morning: Canada’s fiscal mismanagement poses a direct threat to British financial stability. In a rare intervention, the Bank’s Financial Policy Committee cited ‘contagion risk’ from Canadian sovereign debt, which has spiralled to 110% of GDP. Mark Carney’s former colleagues are now ringing alarm bells over a potential repeat of the 1976 IMF crisis, when Britain itself had to be bailed out.
The yield on Canadian 10-year bonds has surged 50 basis points in two days, outpacing even the most distressed eurozone peripherals. Investors are fleeing Canadian assets, and the loonie is in freefall. The Bank of England’s concern is not altruistic.
British banks hold over £40 billion in Canadian exposure, mostly through pension funds and insurers. A Canadian default would rip through the City’s balance sheets. This is the same channel that transmitted the 2008 US subprime crisis to these shores.
The UK’s own gilt yields are already under pressure, with the 10-year rising 12 points this morning. The market is pricing in a 40% chance of a UK rate hike next month to defend the pound. The irony is bitter.
Canada was supposed to be the safe haven of the G7, its banks the envy of the world. But decades of housing bubbles, provincial debt, and now a federal deficit of 8% of GDP have shattered that illusion. The Bank of England is right to be worried.
Contagion is a word we have not heard since 2008. It is back.
