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BMO Bank of Montreal

July 30, 2011 05:00 ET

REPEAT: Debt Ceiling Fallout-What's at Stake for Canada?

BMO provides outlook for economy, borrowing costs, and personal debt ceiling

TORONTO, ONTARIO--(Marketwire - July 30, 2011) - Amid growing speculation of a U.S. government debt downgrade, it's showtime for the U.S. government as the August 2nd deadline is looming to come up with an agreement for raising the $14.4-trillion debt ceiling.

The debate over raising the debt ceiling is not new - since 1962, it has been raised a total of 74 times.

Most expect that both sides will come to an agreement and the debt ceiling will be increased, but the question lingers – what happens if a deal is not reached in a timely manner? What kind of shock waves will roll across the global economy, and more specifically across Canada, as a result? Or if a deal is reached, what is the impact?

Economic Impact

Douglas Porter, Deputy Chief Economist, BMO Economics, says that restraint flowing from a meaningful deficit-reduction deal would keep interest rates low and the greenback weak, stunting the growth of the U.S. economy and, as a result, the growth rate in Canada as well.

"Tough restraint would further reduce the need for the Federal Reserve to raise interest rates anytime soon and would keep the U.S. dollar weak. Furthermore, the restraint will act as a brake on U.S. growth for many years, and in turn, will cap Canada's underlying growth rate," notes Porter.

Mr. Porter also suggests that on the flipside, the Canadian dollar will likely remain robust with the Fed on hold, removing some pressure on the Bank of Canada to raise interest rates.

Mr. Porter cautions that if only half measures are taken to reduce the deficit, it would leave the U.S. vulnerable to ratings downgrades, potential upward pressure on long-term borrowing costs, and could require even greater U.S. fiscal restraint down the road. The outcome would see less near-term U.S. spending restraint, but would also likely lead to a stronger Canadian dollar.

"Canada is a relative safe harbour compared to other problem-plagued economies, but its fundamentals could be heavily marred by negative outcomes from the U.S. debt debate. The risks to the Canadian economy are, on balance, less severe than in 2008, but there is little room for either monetary or fiscal policy to help support the economy if this debate takes an ugly turn."

Borrowing Costs

Paul Taylor, Chief Investing Officer, BMO Harris Private Banking, notes that if the U.S. cannot come to an agreement to raise the debt ceiling, global bond markets and the costs of borrowing will see negative fallout as a result.

"Should the U.S. start defaulting on debt interest payments, U.S. Treasury bond rates will increase, leading to tremendous instability in global bond markets and will drive up the cost of borrowing across the board," said Mr. Taylor. "What this means is that interest rates will soar, making it more difficult for people to borrow to purchase a house or other big ticket items, such as a vehicle."

Mr. Taylor adds that the business sector is not clear of the present danger either, as defaults in the U.S. will mean businesses will not be able to afford their credit lines or invest in capital expenditures, and possibly plunge the economy into another recession.

The 'Personal Debt Ceiling'

So while putting a country's financial house in order is a top priority, it also leads to another important question – are Canadian households moving quickly enough to address their own debt ceilings?

A BMO survey reveals that one in three Canadians are living at or beyond their means, with 27 per cent living paycheque to paycheque – a 10 per cent increase over last year.

BMO Bank of Montreal offers the top 5 tips to avoid hitting your personal debt ceiling:

  • Don't overspend – Spend less than you make. Develop a budget that establishes how household expenses will be paid and how spending will be managed. Take advantage of free online tools, such as BMO MoneyLogic™, to help stay on top of everyday household spending and saving.
  • Curb credit card debt – Pay down credit cards, beginning with those that carry the highest rate, or consolidate credit card debt using a lower rate line of credit. Consider using a low rate card for purchases. For instance, the BMO Preferred Rate MasterCard offers a low rate of 11.9 per cent for an annual fee of $20.
  • Invest to save – Set up a Tax Free Savings Account (TFSA) or high interest savings account to set aside extra cash in case of an emergency. Also consider using Exchange Traded Funds to reduce management expense fees.
  • Become mortgage free faster – Cutting your amortization from 30 to 25 years and increasing monthly payments on mortgages can help you pay down your mortgage faster while saving you thousands of dollars in interest costs. For instance, BMO offers a low 5 year-fixed rate mortgage with a maximum 25-year amortization at 3.79 per cent. Additionally, consider increasing the frequency of your payments and/or making lump sum payments to pay down your mortgage faster. For example, by making a lump sum payment of 5 per cent of the original principal each year, you can pay off a 25 year mortgage in less than 12 years and save over $136,000 in interest.
  • Have a Plan B – Plan ahead and develop a fall back plan in case you are unable to meet your financial obligations due to unexpected circumstances, such as loss of work, or damage to personal property, including your home or vehicle.

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