The Bank of Canada building in Ottawa on Oct. 29. The growth impact from the federal budget, at least over the near term, generates conditions for the central bank to ease rates.Keito Newman/The Globe and Mail
I give the latest federal budget a B- rating, which is better than anything I graded during the Trudeau era. Yes, the deficits now and in the future are far higher than earlier projections, but they are far less than what we are seeing south of the border and are actually middle-of-the-pack when benchmarked against the G10 universe in terms of fiscal largesse. For those lamenting the deficits, keep in mind that we have an economy in the sick bay, which deserves a response to the depressing effects of the Trump tariffs.
Federal budget basics
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There is no appetite in the Liberal Party for broadly based tax rate reductions, including capital gains, which is a non-starter for this group of centrist politicians. But there were some positives worth reporting: using the tax system to promote capital investment (more rapid acceleration of depreciation allowances), moves to fast-track expansion in the resources sector, efforts to downsize government (this is big news for this party), and more generally speaking, whether it be in the industrial or housing sector, a strategy of boosting the country’s capital stock and hopefully future productive capacity, which has been lacking for far too long.
This is the first true “supply side” budget we have seen in Canada in decades. All that said, as with all budgets, there is a long slate of assumptions – and the elephant in the room in this document is the reliance on the private sector to respond to all the incentives, and on the provinces to partner up in order to trigger the expected $1-trillion in infrastructure investments over the coming half-decade.
And the decision to divide the budget accounts into two items, operational and capital, makes perfect sense. This is good economic logic, it is not aimed at obfuscation, but rather is an acknowledgment that program spending with immediate effect is completely different from capital expenditures where success is measured with a much longer timeline. And the aim, at least, is to balance that operational budget within the next three years.
What is interesting is how the government does not expect an immediate economic boost. The estimated effects of the stimulus are to add around a half-point to GDP growth annually over the next two years (for 2026, the Trump stimulus adds a bit more to U.S. growth). So, this budget is not a blockbuster in terms of providing tremendous near-term impetus to domestic demand, though it will help prevent a recession or stagnation period ahead.
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The budget forecast is for a mere 1.1-per-cent real GDP growth profile this year and 1.2 per cent in 2026 (down from 1.6 per cent in 2024). Ergo, this was not a social/program spending budget aimed at stimulating demand growth over the near term as much as taking a stab at promoting an improvement in the country’s long-term potential real GDP growth profile down the road.
When you average out the country’s 1.3-per-cent potential growth rate for 2026, these figures suggest a modest further widening in the disinflationary output gap, which the Bank of Canada estimates as being between 0.75 per cent and 1.75 per cent presently. Yet the budget assumes that there will be no more rate cutting out of the central bank, even though the growth impact from this budget, at least over the near term, actually generates the conditions for the BoC to take the policy rate below the 2.25-per-cent to 3.25-per-cent neutral range (now at the low end) – after all, it sliced below the low end of that range in each of the past five easing cycles.
As an aside, the projections from the Department of Finance are not altogether different from the Bank of Canada, which now sees 1.2-per-cent real GDP growth this year and 1.1 per cent in 2026. The initial negative reaction by the Canadian dollar and the modest drop in GoC yields look to be rather appropriate under the circumstances.
If these forecasts prove prescient, it will mean four consecutive years of sub-2-per-cent real GDP growth for the Canadian economy (this budget puts a floor under an otherwise moribund economy, but does not exactly prove any real growth impetus over the near term, and certainly not enough to reflate or close the output gap). Going back to 1962, this has never happened before.
Today’s forecast would be a worse multiyear performance than what we saw in the double-dip downturn of the early 1980s or the Great Recession nearly two decades ago. Interest rates and bond yields should stay on their downward trajectory, and that goes for the loonie as well.
Not just that, but look at Ottawa’s projection of nominal GDP growth – from 4.7 per cent last year to 3.5 per cent this year to a mere 3.0 per cent in 2026. This sort of moribund performance has happened little more than 10 per cent of the time in the past six decades. And with few exceptions, it was during outright recessions. On average, the BoC’s reaction function was to cut rates by a full percentage point and the 10-year GoC bond yield fell more than 40 basis points.
As for the Canadian dollar, in periods where nominal GDP growth was 3 per cent or lower, the loonie sold off by 4.5 per cent and was down practically each time. A move toward $1.48 (67.6 US cents) from $1.41 (71 US cents) looks to be in our future if the past is prescient.
David Rosenberg is founder of Rosenberg Research.