Rate cuts could come by June 2024 — but government spending will play a role: CIBC

Reining in government spending could take some of the pressure off the Bank of Canada in tamping down inflation and help limit pain for debt-ridden Canadians, according to a new report from CIBC.

The central bank’s return to rate hikes last week with a 25-basis-point increase has economic forecasters hurriedly revising their outlooks for inflation and interest rates, with CIBC also turning its lens on the role played by fiscal policymakers.

In the report released Monday from chief economist Avery Shenfeld and senior economist Andrew Grantham, CIBC forecasts another rate hike of a quarter percentage point from the Bank of Canada in July or September, which would bring the policy rate to 5.0 per cent.

Rate cuts, meanwhile, aren’t expected to come until June 2024, according to CIBC forecasts. The central bank policy rate is projected to fall to 3.5 per cent by the end of next year, CIBC predicts.

Rates are going to have to stay higher for longer in the status quo, the CIBC economists argue, unless there’s a shift in approach from federal and provincial governments to help the Bank of Canada with its goal of getting inflation back to its two per cent goal.

While the Bank of Canada’s primary tool to achieve its inflation mandate is to set the cost of borrowing using its benchmark rate, governments can have an impact on that progress by slowing or ramping up demand based on their spending and policy objectives.

Fiscal stimulus that puts more money in the pockets of Canadians, for example, can fuel demand and inflation, in turn.

Federal Finance Minister Chrystia Freeland often noted in presenting the Liberals’ 2023 budget that she would exercise “fiscal responsibility” in charting the country through a period of cooling-but-still-high inflation and economic uncertainty on the horizon.

That budget, which passed through the House of Commons last week in Ottawa, has been heavily criticized by the federal Conservatives as overspending.

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The authors argue in the CIBC report that while each level of government was effective in winding down stimulus tied to the COVID-19 pandemic in 2022, fiscal restraint has since been waning.

“It’s not that fiscal policy is significantly fueling the inflation we’re now seeing, it’s that it would be even better if, at least in the near term, it was actually putting some downward pressure on inflation by helping to cool off the fire,” the report reads.

And while the federal opposition has put the Liberal government’s spending plans in the crosshairs, the CIBC report points primarily at the provincial spending plans as fuelling demand.

The “drag on growth” needed to rein in inflation “would have been much larger without a surge in provincial spending,” the report states.

Much of this extra spending came in the form of tax rebates branded as ways to help Canadians cope with high inflation — but CIBC argues this support went past inflation relief and verged into stimulus.

While the provinces could be chastised for last year’s spending plans, Ottawa has its share of blame in the 2023 federal budget, Shenfeld and Grantham argue.

The upcoming “grocery rebate,” which will be distributed next month, will add a projected 0.4 percentage points to gross domestic product (GDP) in the second quarter of the year if all spent, according to CIBC’s projections.

Altogether, the federal and provincial spending plans won’t end up as much of a drag on growth this year, leaving the Bank of Canada’s interest rates left to do the bulk of the work, according to CIBC.

The higher interest rates need to go, and the longer they stay there, will have other knock-on effects, per the report.

Governments at all levels have identified home construction as something that will need to speed up to accommodate Canada’s population growth in the years ahead, but high interest rates have an acute impact here, slowing down the pace at which shovels get into the ground.

“That’s hardly ideal in an environment in which a shortage of housing is pressuring apartment rents and the overall cost of home ownership,” the report reads.

Canadian homeowners coming up for mortgage renewals in the next couple of years are also slated for significant pain as their payments rise to reflect higher interest rates; CIBC calls this a “significant risk to household financial stability” if the Bank of Canada’s policy rate remains at high levels.

A “somewhat tighter fiscal path” would allow the central bank to start cutting its interest rate sooner, the authors say, or limit how high monetary policymakers have to take the rate in the first place.

CIBC looks ahead to the fall fiscal updates from the provinces and federal government and warns of announcing additional spending as a risk for higher interest rates and more financial pain for Canadian households.

Freeland, speaking after the Bank of Canada’s latest rate decision last week, was asked whether higher-than-anticipated government spending in the 2023 federal budget was a concern she had discussed with Bank of Canada governor Tiff Macklem.

She reiterated that Ottawa and the central bank operate independently in setting fiscal and monetary policy but have “clear lines of communication.”

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