While it doesn’t anticipate U.S.-style deleveraging, TD Economics says that Canadian households are carrying too much debt.

In a new report published Wednesday, TD says that the relentless rise in household debt in Canada, “is a growing cause for concern”. It reports that since the mid-1980s, total household debt as a share of disposable income in Canada has almost tripled — from 50% to 146%. TD Economics estimates that the appropriate level of personal debt-to-income ratio is about 138%-140%.

“A U.S.-style crisis is not in the making, but Canadian personal debt growth must slow relative to its past rapid pace of increase,” it says. While there are factors pointing to a slowing in household borrowing, TD says that a sustained period of low rates could support 5% annual growth in borrowing, and with incomes only expected to rise 4% annually, the debt-to-income ratio could hit 151% by 2013.

“This suggests that further prudential actions might be warranted,” TD says, or the Canadian economy could have its own painful deleveraging. Although it maintains that this should not occur until the current housing cooling has run its course and the economy is on a firmer footing.

However, TD also warns that it remains concerned about two negative risks in particular: a negative shock to income growth, or a renewed wave of borrowing that could lead to a more painful consumer adjustment down the road. “The odds of either event happening is material, but not high enough to be the most likely scenario. We would put the odds of either outcome at perhaps 1-in-3,” it says.

“One final alternative to our base case forecast is the most desirable outcome, where the Canadian economy performs much better than anticipated, income growth surprises on the upside and this allows the debt-to-income ratio to moderate,” it says, adding, “This would be ideal, but can’t be counted on.”

In the meantime, TD Economics expects the overnight rate to eventually rise to 3.50% in 2013. “This will create financial stress on some Canadian households, but not the majority,” it says. And, while it doesn’t believe that a US-style household debt crisis is likely, it says that policymakers and lenders “should be aware that personal indebtedness is becoming a more pressing problem, and low-income Canadians are particularly vulnerable to future interest rate increases.”

IE