Additional Canadian government spending challenges central bank

Despite Deputy Prime Minister of Canada Chrystia Freeland's pledge not to make the Bank of Canada's job harder, Canada plans to spend an additional CAD$6.1 billion (US$4.5 billion). This plan is especially dangerous as it could undermine efforts to curb inflation over the next 5 months.

While the spending package is relatively modest in scope and builds on existing federal stimulus measures and consumer payments, it raises concerns about stimulating Canada's already-hot economy.

After the government announced a huge increase in jobs in October, the likelihood that the Bank of Canada will have to sharply raise interest rates for the sixth time in a row at its next meeting has increased sharply.

According to Derek Holt, vice president of capital markets economics at Scotiabank, a reduction in the spending line would be desirable. Thus, according to Holt, the likelihood of a decrease in the number of rates in the future is reduced.

Holt assured that the onus is still 100% on the Bank of Canada.

Currently, money markets are leaning towards the Bank of Canada raising its policy rate by half a percentage point on December 7th. The increase in the policy rate will be an addition to the 350 bps worth of tightening that the Bank has already undertaken in March 2022. The Bank of Canada policy rate is expected to peak at 4.5% in early 2023.

Economists said the government's underlying expectations for economic growth of 0.7% next year were optimistic. The reality is likely to be closer to a 0.9% GDP contraction in the worst-case scenario.

According to Doug Porter, chief economist at BMO Capital Markets, it will be difficult for the government to see any improvement in the coming fiscal year. Porter also mentioned the fact that the fiscal measures were working at a slight crosscurrent to monetary policy.

Scotiabank estimates that cumulative stimulus measures will exceed CAD16 billion in the coming quarters. At the same time, the federal government announced new spending of CAD$22.9 billion for 2022 and 2023.

Although inflation in Canada has eased to 6.9% from a recent peak of 8.1%, it is still well above the Bank of Canada's 2% target.

Chrystia Freeland said the Canadian government has taken the right approach to walk a delicate line between offering help to those suffering from high inflation and the need for fiscal restraint.