Canada Can't Kick its Stimulus Habit as Trump Fuels Trade Risks

(Bloomberg) -- Canada’s in no hurry to end an era of stimulus.

In just over a week, three of the nation’s most important economic policy makers have signaled they’ll keep supporting an economy that’s already close to running hot. Bank of Canada Governor Stephen Poloz held interest rates steady; Federal Finance Minister Bill Morneau’s budget added new spending; and Ontario Finance Minister Charles Sousa, having already balanced his budget, is plunging back into the red.

The risk is the spending, instead of boosting growth, fuels inflation that could ultimately undermine Canada’s economy -- while leaving governments with debt-heavy balance sheets whenever a recession strikes.

“We are choosing to put our strengthened fiscal position to work,” Sousa said Wednesday in Toronto, announcing he’d deliver a budget on March 28 with a deficit of less than 1 percent of gross domestic product, which would mean less than C$8 billion ($6.2 billion). This year’s budget is balanced, he said. “I see challenges ahead.”

Canadian provincial and federal governments are projected to run a cumulative deficit of C$31.9 billion in 2017-18, fiscal tables published by Royal Bank of Canada show. That’s about 1.4 percent of GDP. Ontario’s new deficit would push the 2018-19 total to as much as $37.3 billion, or about 1.6 percent of GDP.

The reasons are varied. Governments, for instance, have introduced new program spending aimed at reducing poverty and income inequality. The economy also faces a number of economic headwinds and risks -- Donald Trump among them. Canada’s economy remains vulnerable to steel and aluminum tariffs while talks continue on a revamped North American Free Trade Agreement. Business investment also may be faltering in an era of uncertainty.

Politics is a factor. Ontario’s next election is in June, and Sousa used his speech Wednesday to attack his party’s top rival. Morneau’s budget included repeated elements of political posturing ahead of a federal vote in 2019.

Bank Sees Uncertainty

The Bank of Canada, which has lifted borrowing costs three times since July, indicated on Wednesday it’s in no rush to pursue further hikes in any aggressive way, citing the growing global trade tensions and softer housing data.

While global growth is “solid and broad-based,” recent developments in trade policy have become “an important and growing source of uncertainty” for the Canadian economic outlook, the central bank said.

Morneau, meanwhile, has regularly called current interest rates “accommodative” and said Wednesday that’s “providing opportunities for businesses, for individuals, to be able to borrow money at favorable rates.” By the central bank’s own measure, interest rates are still extremely stimulative, about 2 percentage points below what it would consider “neutral” even with the economy operating at close to capacity.

Morneau defended his fiscal plan that includes deficits that are 0.8 percent of GDP. Business groups such as the Canadian Chamber of Commerce and the Business Council of Canada have called on him to rein in the deficit.

“The same people who say you need to lower taxes are the same people who say you need to balance the budget,” he said, adding the U.S. deficit on a per-capita basis is five times the size of Canada’s.

‘Forgone’ Capacity

Given all the trade developments, one could argue “risks are tilted to the downside, and maybe running a little bit looser for longer isn’t necessarily a bad thing,” said Jean-Francois Perrault, senior vice-president and chief economist at Scotiabank. “But we’re not there yet,” he said, given the economy is still forecast to grow above its potential.

On Ontario’s plan, Perrault said it will depend on how the deficits are used and could be seen as a positive if they go toward boosting business competitiveness.

Ontario has already funneled a windfall from strong growth and its cap-and-trade program into higher spending, Bank of Montreal Senior Economist Robert Kavcic said in a research note. “We are late in the cycle — perhaps very late. Significant fiscal capacity to combat the next downturn is being foregone.”

It’s not all deficits in Canada. Quebec has a balanced budget while British Columbia projects a narrow surplus. Alberta’s budget gap, the largest among the provinces, is expected to shrink in coming years. Even Prime Minister Justin Trudeau’s deficits are smaller than what were projected only a year ago as the economy performed better than expected. The overall trend in Canada was supposed to be one of narrowing deficits, until Ontario chose to take up that fiscal space.

©2018 Bloomberg L.P.