Canadian consumer confidence has recovered, but with rising debt levels and softening growth in real disposable income, a new report by CIBC World Markets Inc. predicts that consumer spending will disappoint in the year ahead.

The latest Consumer Watch report says that consumer confidence has improved by 60% since reaching a 15-year low in 2008, and has returned to its long-term average. This boost in confidence drove up consumer spending last quarter, with personal purchases climbing nearly 4% on an annualized basis.

But with consumer fundamentals remaining weak, strong spending growth will not continue, warns Benjamin Tal, senior economist at CIBC.

“Despite Canadian consumers’ high spirits, their recent consumption pattern has not been supported by an equivalent increase in income,” he says in the report. “While improved sentiment can provide a short-term lift to household spending, a sustainable boost in activity must eventually be backed up by improving consumer fundamentals such as income growth, falling unemployment and reduced debt burdens.”

Canadian consumer fundamentals are in fact weaker than they have been in almost 15 years, according to the report. The ability of households to spend deteriorated in the second half of 2009 as growth in real disposable income has trended downward.

Furthermore, the household debt-to-income ratio in Canada has continued to climb, reaching a record high of 147% in December 2009.

Canadians’ debt-to-asset ratio also trended upwards during the recession, with liabilities rising twice as fast as assets. Recent quarters have seen some stabilization in this ratio but its level remains relatively elevated, according to the report.

These factors will hamper the ability of consumers to keep spending in the year ahead, according to the CIBC Consumer Capability Index.

“The practical implication of the reduced consumer capability is that consumer spending will disappoint in the coming 12 months,” Tal says.

He notes that their high debt levels mean consumers will be hit hard by a boost in interest rates, which will contribute to the weak spending.

“Given the vulnerable starting point of the consumer, the Bank of Canada will soon find that even a moderate monetary squeeze will be sufficient to drive a material deceleration in consumer spending,” he says.

IE