Canada should resist further spending amid U.K. turmoil, analysts say

Prime Minister Justin Trudeau’s government should avoid new stimulus when it updates its fiscal plans this fall and focus instead on paying down debt as governments globally face greater scrutiny managing their finances, analysts said.

The reason for caution is clear given the market reaction to Britain’s plan to cut taxes without explaining how to pay for it, analysts said. The pound crashed to a record low against the U.S. dollar and British government bonds tanked.

“It’s more important than it has been in many, many years for the federal government to reassure (investors) that it is nowhere close to following the U.K.’s path,” said Royce Mendes, head of macro strategy at Desjardins Group.

Finance Minister Chrystia Freeland is due to present the annual fall economic statement in November.

“The government remains committed to reducing the federal debt-to-GDP ratio, and federal deficits, and the budget this year met this test,” Adrienne Vaupshas, press secretary in the minister’s office, said.

“It is important for fiscal policy not to be working against monetary policy as we deliver compassionate and targeted affordability support for Canadians,” Vaupshas added.

Looser fiscal policy could undercut the Bank of Canada’s efforts to subdue inflation and economists say the federal government should delay planned spending to next year when the economy is expected to contract.

So Trudeau may be forced to hold onto an expected revenue windfall, a move that clashes with the government’s recent tendencies.

Trudeau spent some $290 billion in direct aid to individuals and businesses during the COVID-19 pandemic, and promised nearly $180 billion in stimulus over five years last year. Even in this year’s budget, introduced while inflation soared, he set out nearly $10 billion in new spending over five years.

Since the 2022-23 budget was presented in April, inflation and higher prices for commodities including oil have driven tax revenues higher.

Scotiabank Vice President Rebekah Young estimates that windfall will lower this year’s deficit to around $35 billion, or 1.2 per cent of GDP, compared to the $52.8 billion budget forecast. The deficit hit 14.9 per cent in 2020-21, while it was running around one per cent in the years before the pandemic.

The government should “pay down debt so that when there is more capacity to make new investments they are ready to run with it,” Young said.

Canada’s general government net debt-to-GDP ratio, which includes provincial debt, is the lowest among Group of Seven wealthy countries and the IMF expects it to decline slightly to 30.3 per cent of gross domestic product next year.

Still, if it were to decline more quickly, the government could tackle some long-term challenges once inflation, at seven per cent in August, comes down.

In particular, transitioning to a greener economy and scaling up a new clean tech industry will require significant investments, economists said.

“At the moment, inflation is high and it hasn’t shown any signs of decelerating in terms of underlying core measures,” said Desjardins Group’s Mendes. “That is the number one issue facing the economy.”

To soften the blow of inflation, the provinces and the federal government already have announced some $21 billion in stimulus, which will feed into the economy in coming months, Young said.

Mendes’ recommendation for the fiscal update is simple: “Tread cautiously.”

by Reuters