The Bank of Canada was widely expected to continue bringing its benchmark rate lower in the months ahead, although by how much remained anyone’s guess.
Still, plenty of factors could complicate the central bank’s plans on rates—not least the prospect of a dramatically higher national deficit, which has raised fears of mounting investor unease and upward pressure on inflation.
National Bank of Canada’s chief economist, Stefane Marion, projected that Ottawa’s fiscal shortfall would reach $100 billion this fiscal year, more than double the $42 billion the government forecast in December.
Speaking at Bloomberg’s Canadian Finance Conference, Marion called the upcoming fiscal update “the most consequential budget in a generation” and flagged a decade of “suboptimal” economic policy as a key backdrop.
“We do have some fiscal room when you compare Canada to the rest of the world,” Marion said. “We should not waste it.”
He pointed to Canada’s relatively strong position among G7 countries, but warned that the government’s ambitious spending plans, spanning infrastructure, defence, and housing, could test the country’s fiscal resilience.
Deficit pressures could limit rate cuts
A surging deficit—when the federal government spends significantly more than it collects in revenue—could have significant implications for the Bank of Canada’s rate trajectory.
A larger deficit typically means the government must borrow more by issuing bonds. If investors become concerned about the size or sustainability of Canada’s deficit, they may demand higher yields to compensate for perceived risk. This pushes up government bond yields, which serve as a benchmark for other borrowing costs across the economy, including mortgages.
Inflation and central bank caution
Moreover, heavy government spending can stimulate demand in the economy. If the economy is already running near capacity, this extra demand can fuel inflation.
The Bank of Canada’s primary mandate is to keep inflation in check. If inflation risks rise due to deficit spending, the central bank may be forced to delay or limit rate cuts, even if economic growth is sluggish.
While Canada’s fiscal position remains stronger than many G7 peers, a rapid increase in the deficit reduces the central bank’s flexibility.
If fiscal policy is highly stimulative, the Bank of Canada may worry that cutting rates too aggressively could overheat the economy or undermine the currency.
A surging national deficit, especially one that pushes toward three per cent of GDP, could mean the Bank of Canada is more cautious about cutting rates.
Even if economic conditions would normally justify lower rates, concerns about inflation, investor sentiment, and higher government borrowing costs may force the central bank to pause or slow the pace of cuts.
For mortgage professionals, this means rate relief could be less predictable and more dependent on fiscal decisions coming out of Ottawa.
Investment, productivity, and the road ahead
Meanwhile, Marion and other economists have argued that targeted investment, particularly in infrastructure and energy, could help boost Canada’s lagging productivity. “We’ve been stranding these assets by not knowing whether or not we could exploit them down the road,” Marion said.
He also cited the country’s clean electricity sector as a major opportunity for foreign investment.
Still, the Bank of Canada’s next moves will likely hinge on the details of Ottawa’s budget. Marion predicted a quarter-point rate cut to 2.25% at the next meeting, but said policymakers would probably pause to assess the fiscal outlook. “It will be a stimulative budget,” Marion said.
CMP
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