Federal budget does not change fiscal track, says BoC’s Macklem

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Bank of Canada Governor Tiff Macklem said this week’s federal budget has not significantly changed the government’s fiscal path and is unlikely to affect the country’s macroeconomic trajectory in the near-term.

Speaking to reporters on Friday from the International Monetary Fund spring meeting in Washington, Mr. Macklem said it was helpful that Ottawa had stuck to its fiscal guardrails – a self-imposed cap on the size of government debt and deficits. Despite adding around $53-billion in new spending over five years, Tuesday’s budget was essentially a wash in terms of its impact on aggregate demand in the near-term, Mr. Macklem said.

“At a macro level there’s more money going out, there’s more money coming in,” he said, noting that the government is increasing its revenues as a result of stronger-than-expected economic growth and an increase in capital-gains taxes for companies and wealthy individuals.

“On net, the fiscal track has not substantially changed relative to the fall economic statement. So different measures can have different fiscal multipliers, but first order, doesn’t look like a big change.”

Ahead of the budget, Finance Minister Chrystia Freeland had said she was trying not to make the Bank of Canada’s job harder by adding to inflation, which could delay a decline in interest rates.

Last year, Mr. Macklem said the pace of government spending, at the federal and provincial level, was neither helping nor hindering the central bank’s efforts to bring down inflation.

Since then, most provincial governments have released budgets showing significant increases in spending and larger deficits. The federal budget kept the deficit projection for this year essentially the same as in the fall economic statement, although it projected slightly larger deficits in future years.

Mr. Macklem declined to comment on whether the change in capital-gains tax in this week’s budget will affect productivity. This measure increased the inclusion rate for taxes on capital gains to two-thirds from one-half for companies. The inclusion rate increased for individuals as well, but only for capital-gains earnings more than $250,000 a year.

A number of business organizations have criticized the change, saying that it will discourage entrepreneurship at a moment when the country is already struggling with low business investment and weak productivity.

The latest inflation data, published on Tuesday, showed 2.9 per cent annual Consumer Price Index growth in March. The bank targets 2 per cent. Encouragingly, core inflation measures, which strip out the most volatile price changes, also trended lower.

Mr. Macklem said the latest data showed inflation taking “another step in the right direction,” although he said he needs to see more progress before being confident enough to start lowering interest rates. The bank’s benchmark rate has been at a two-decade high of 5 per cent since last summer.

After the bank’s rate decision last week, Mr. Macklem said a rate cut in June was “within the realm of possibilities,” although not a sure thing. Financial markets are pricing in a roughly 50-per-cent chance that the bank starts lowering rates in June.

There are still upside risks to inflation. In particular, the rising conflict between Israel and Iran is creating volatility for oil prices.

“If there’s a spike in oil prices, that is something we’ll have to take into account,” Mr. Macklem said, although he noted that the bank is primarily focused on core inflation measures which exclude gas prices.

The strength of the U.S. economy is another potential constraint on the Bank of Canada lowering interest rates. Inflation has been higher and economic growth has been stronger in the U.S. than in Canada. That’s led markets to push back expectations of rate cuts from the U.S. Federal Reserve.

If the Bank of Canada cuts rates before the Fed, and lowers them faster, that would put downward pressure on the Canadian dollar and increase the price of imported goods, such as food.

Mr. Macklem said this divergence is not a significant issue.

“Central banks, whether you’re the Eurozone, Canada, Sweden, Australia, the U.K., you name it, we have our own currencies. We have flexible exchange rates. Those flexible exchange rates absorb the differences. They allow us to actually run monetary policy that’s geared to our own domestic circumstances.”

He said that financial markets are working as expected, with changing assumptions about diverging monetary policy showing up in exchange rates and bond prices.

“The adjustments have been relatively smooth,” he said. “The international monetary system from that perspective is working well. And I think as long as countries continue to have sound fundamentals we continue to communicate clearly, that will continue.”