Budget prep begins amid January slumber
While Ottawa slowly stirs from its holiday slumber, Parliament remains in snooze mode. The pace will begin to accelerate next week, particularly at Finance Canada, which will soon be running at full speed in its budget prep.
Finance Minister Chrystia Freeland is dealing with a more demanding economic landscape in 2023.
The country is facing slow growth and higher borrowing costs that will lead to weaker revenue and higher debt payments. A likely increase in the jobless rate will ramp up demands on the fiscal purse.
The governing Liberals will also need to address demands from provinces for more health-care transfers, fund initiatives under the governing agreement with the NDP and heed calls from business for a robust response to President Joe Biden’s Inflation Reduction Act. This means Freeland’s message at the planned cabinet retreat in Hamilton, Ont., Jan. 23-25, may be one of tempered expectations.
Interest rates could increase, risks for Freeland
As if on cue to highlight the coming challenges for Trudeau’s government, the Bank of Canada may hike interest rates again the morning of Jan. 25, just as the cabinet retreat is wrapping up
To recap, the central bank increased its benchmark interest rate by four percentage points last year, to 4.25 per cent. Prime rates offered by commercial banks are now hovering at around 6.5 per cent.
The higher interest rates of course are being implemented to counter an even bigger risk to the economy — four-decade high inflation that has left policy makers with few good options.
The rate hikes will put a strain on Canada’s indebted households in 2023, but most economists and the government are still anticipating a soft landing whereby inflation drops sharply but the economy is seen eking out a bit of growth.
There are some serious tail risks for Freeland, however.
One is the economy is much more sensitive than expected to the already implemented rate hikes, creating a deeper-than-anticipated downturn.
The other is the economy doesn’t cool enough, and inflation persists. That will handcuff Freeland’s ability to use fiscal policy to address some of those pending political demands for fear of fueling inflation further and driving interest rates even higher. Strong jobs data out on Friday highlight how upside risks to inflation remain real.
Either way, the historical record isn’t comforting – high inflation like we’ve seen typically leads to large downturns and political turmoil, eventually.
In its latest projections, the Bank of Canada sees inflation averaging 4.1 per cent in 2023, down from 6.9 per cent last year.
A drop of at least that magnitude has occurred only three times in the past six decades. It happened in 1983 and 1992, only after the economy suffered deep recessions. It also happened in 1976, the year Trudeau père introduced wage and price controls. In each case, the government would eventually lose power in the ensuing election.
The federal government has bypassed some of the tough fiscal decisions so far by assuming not only a soft landing for the economy in the short-term but an optimistic medium-term outlook.
Freeland’s last fiscal plan released in November assumes growth will average 1.8 per cent over the next five years — about the average of the past 20 years – despite an aging workforce.
That may turn out to have been a risky assumption to make.
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