Last week, the federal government unveiled their first post-pandemic budget, focused squarely on fire-starting economic growth. It packs $60B in spending for initiatives -- such as $10B alone being earmarked for housing issues -- along with national defence, dental care, and climate change.
While overall, the budget has been considered a “modest” one as the government attempts to fiscally recover from enormous COVID-era social supports, this new whack of spending comes at a time when inflation is hovering at a three-decade high -- and Canadians can expect to absorb the consequences of that via a more aggressive interest rate hiking cycle. Translation: bigger rate hikes are coming, and more of them.
BoC Will Have Little Choice But to Hike Faster
The Bank of Canada (BoC) has been tasked with the mandate of reining in inflation, which has been running historically hot in recent months as the economy rebounds from lockdowns, commodity costs soar, and supply chains remain ensnarled. The March reading clocked in at 5.7%: a 31-year record, and well beyond the 2% range that would typically trigger a rate hike.
That the central bank must take an increasingly aggressive approach has been well documented; while liftoff officially started in March with a 0.25% increase, the next few are to be supersized; all six of Canada’s big consumer banks are unanimous in calling for a 0.5% rate hike in the BoC’s April 13 announcement, the first since 2000. Markets, meanwhile, are pricing in roughly three more half-point increases before the year’s end.
That’s going to accelerate borrowing costs considerably faster than if the BoC had stuck to its usual cadence of quarter-point increases. But, as inflation continues to surge to new highs, monetary policy makers will have little choice.
In a BMO Economics note authored by economists Robert Kavcic and Douglas Porter, they write that the budget has effectively improved the projections for Canada’s deficit and debt picture. However, the impact on inflation can’t be denied, with new policy measures to add “roughly 0.3 ppts to growth this year, at a time when an inflation battle is well underway.”
“As we have long maintained, fiscal policy has a very big role to play in controlling inflation as does monetary policy. And, with inflation clocking in at a 30-year high of 5.7%, and likely headed higher, there is some urgency for the task at hand,” they write.
“The Bank of Canada is in the early days of reversing course, with potentially rapid tightening measures on the near horizon -- we see the overnight rate rising 150 bps by year-end to 2.0%, higher than pre-pandemic levels. For fiscal policy, the appropriate stance with the economy operating at full capacity and revenues rising rapidly would have been to let the windfall largely flow through to the bottom line. Instead, the focus in the Budget is channelling a healthy portion of the revenue windfall to new priorities, while also layering on additional net tax increases. That said, a number of the new measures do commendably focus on the supply side of the economy, targeting investment in some sectors, as well as the availability and mobility of labour. And, because some massive pandemic-era programs are rolling off, program spending does fall meaningfully this fiscal year. On balance, this fiscal policy calibration will keep the onus squarely on the Bank of Canada to control powerful inflationary pressures.”
Government Debt is Piling On
"A sane amount of fiscal spending was essential to avoid massive defaults and lasting unemployment during COVID. [The] problem is, the government has abused is taxpayer-funded credit card with too many wasteful income redistribution programs that are inflationary and fiscally precarious long-term," Rob McLister, Mortgage Analyst at MortgageLogic.news, tells STOREYS.
While pandemic stimulus spending was a necessity during the worst of the pandemic lockdowns, he adds that the government "hasn't made those hard choices" to strike balance between unemployment and inflation. And, while much of the causes behind runaway inflation are beyond the government's control -- such as spiking oil prices due to the Russian-Ukraine conflict -- the government does carry some of the onus.
"Even the staunchest free-spending proponents of modern monetary theory (MMT) say you've got to cut back on fiscal stimulus when inflation is far above target. Our Finance Minister talks about low debt-to-GDP, yada, yada, but doesn't realize one thing. When the next recession hits, she'll have to pay the piper or go into even further debt. And then when does it end?"
READ: As Fixed Mortgage Rates Hit 4%, Fewer Buyers Can Afford to Lock In
This fresh round of fiscal spending will also support the fierce upswing seen in the bond market in recent months; government five-year yields have spiked 70 basis points (bps) in the last month along, and over a full percent in the last three. As a result, lenders have increased their fixed-rate mortgage prices, with new applicants facing some of the toughest stress testing and qualification criteria seen in years.
"Over-spending with full employment and an overnight rate near emergency lows is rocket fuel for yields. Bond traders aren't stupid," McLister adds. "They know the risks of fiscal imprudence and it's partly why they're dumping Canadian bonds. We'll likely see most banks push five-year fixed rates past 4% within days as a result. That's over double the rates of last September. It didn't have to be this bad. And it's not over yet..."
It's "That Much More Complicated"
That stance is echoed by comments made by David Rosenberg, Founder and President of Rosenberg Research and Associates, to BNN Bloomberg, emphasizing that the timing of the government spending infusion couldn’t be worse from a monetary policy perspective.
“We are basically a fully-employed economy so you don't really need to add demand fuel to the fire when the economy has no output gap and the central bank is behind the eight ball. So this is going to fuel more interest rate hikes in the country against the backdrop of fiscal stimulus that is not well timed, in my opinion,” he said.
“What bothers me is that the government just... made the Bank of Canada's anti-inflation strategy that much more complicated because when you look at the budget, it adds about one-third of a percentage point to this year's aggregate demand growth that it doesn't really need from a government sector. And actually, when you think about it, it’s exactly the wrong time of the cycle,” he said.
“Of course, at the margin, that's going to cause the Bank of Canada to become even more aggressive. But at the same time, the Bank of Canada is not operating policy in a vacuum. Look what's happening in the U.S. and I think that you know, the Bank of Canada probably will move in lockstep with where the U.S. is going to be going. I don't think that we're going to be deviating a lot.”
