By Julie Gordon and David Ljunggren
OTTAWA (Reuters) - Bold policy actions taken in response to the coronavirus pandemic were needed but will make Canada's economy and financial system more vulnerable to economic shocks down the road, the governor of the Bank of Canada said on Thursday.
Tiff Macklem, speaking by video conference to a financial risk management group, said Canada came into the pandemic with a number of vulnerabilities and that it "seems certain" the country would exit with higher levels of government debt.
"As much as a bold policy response was needed, it will inevitably make the economy and financial system more vulnerable to economic shocks down the road," Macklem said.
"Without the fiscal and monetary policy actions, the economic devastation of the pandemic could have been much, much worse," he added.
Macklem reiterated that a full recovery from the COVID-19 crisis would take a long time and noted that many risks remain, particularly as a second wave of infections takes hold in parts of Canada.
"Nobody wants to return to lockdown, but a second wave could test our resolve to practice physical distancing and keep the pandemic from spreading uncontrollably again," he said.
The Canadian dollar held on to modest gains after Macklem's speech, up 0.1% at 75.52 cents, or 1.3242 to the U.S. dollar.
Macklem also said the Bank of Canada was keeping a close eye on household debt levels and Canada's housing market, both of which were vulnerabilities coming into the pandemic.
As bank mortgage deferral programs have expired, the vast majority of people have returned to regular payments, he said. The housing market, meanwhile, has not returned to "frothy" conditions seen in 2016, he said.
Macklem said the central bank is watching Canada's financial system to assess the risk that credit losses could become large enough that banks would need to tighten credit conditions.
"If this happens, our banking system would go from being a tailwind that supports recovery to being a headwind," Macklem said.