Bank of Canada sees easing of housing vulnerabilities

OTTAWA (Reuters) - Vulnerabilities created by Canada's high household debt and hot housing market remain elevated but should ease over time as a stronger economy and tighter mortgage requirements help improve conditions, the Bank of Canada said on Tuesday.

The central bank's assessment of the risks facing Canada's financial system was more upbeat than it was six months ago. It said continued demand and limited supply should support house price growth in Toronto and Vancouver, but higher interest rates and tighter rules should weigh on activity.

Analysts said the cautiously optimistic tone of the report did little to change their expectations that the bank will wait until 2018 before raising rates again, after back-to-back hikes in July and September.

Immediately after the report, the Canadian dollar pared losses against its U.S. counterpart, bouncing off a one-week low hit earlier against the greenback as oil prices fell.

The closely watched report noted an improving labor market, especially employment growth, and said a moderate increase in mortgage rates would be "significant but manageable" for most borrowers. Canada's household debt had hit record levels as buyers stretched to get into a roaring housing market.

"The risks are essentially unchanged. However, the policy changes affecting housing finance are clearly a step in the right direction," Governor Stephen Poloz said in a statement.

Asked whether the easing of the risk around household debt and the precarious housing market cleared the way for more rate increases, Poloz said all factors were working in the same direction.

"So there's no fundamental inconsistency. You have an improving economy. That improving economy led us to take a couple of those interest rate cuts off the table," Poloz told reporters during a news conference.

While financial markets expect more rate increases in 2018, analysts said the return to more normal monetary policy from the ultra-low rates of recent years will be gradual, and limited.

"They are finding some comfort in the data when looking into the details .... But I still think household debt is a valid concern for everybody and that puts a cap on how far rate hikes can go," said Fred Demers, chief Canada macro strategist at TD Securities.

The report signaled the bank has taken some comfort in signs of improvement as regulators clamp down on lending, but it warned a rise in the use of home equity lines of credit (HELOCs) may contribute to increased household vulnerabilities, especially if unemployment rises.

(Reporting by Andrea Hopkins and Leah Schnurr; editing by Jonathan Oatis and David Gregorio)

By Andrea Hopkins and Leah Schnurr