Trudeau Reopens Spending Playbook, Shaking Up Bets for Rates, Growth

(Bloomberg) -- Canadian Prime Minister Justin Trudeau signaled a return to his free-spending playbook as inflation wanes and an election looms, accelerating a bond selloff due to expectations of faster growth and a deeper deficit.

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On Thursday, Trudeau announced a C$6.3 billion ($4.5 billion) tax break and rebate package. It includes a two-month halt on federal sales tax on a variety of items including Christmas trees, wine, toys and books, as well as a C$250 check for nearly 19 million Canadians — close to half the population.

The announcement appeared to mark the end of a brief chapter of greater fiscal restraint. For more than a year, Finance Minister Chrystia Freeland has promised to limit budget deficits to avoid fueling inflationary pressures.

Now, inflation is back to the Bank of Canada’s 2% target, and policymakers have already trimmed the benchmark interest rate by 125 basis points since June. Trudeau’s Liberal government sees a green light to dig deeper into the public purse — but some analysts say investors are keeping close tabs on the country’s indebtedness.

“Markets are no longer willing to give governments a free pass when it comes to fiscal stimulus like this. Even though this is relatively small in the big picture, it means more debt, all else equal,” Taylor Schleich, a rates strategist with National Bank of Canada, said by email.

Bonds continued a selloff on Thursday after the announcement, and the 10-year benchmark yield rose 7 basis points on the day to 3.457%. After retail data on Friday showed a consumer spending rebound, it spiked as high as 3.488%.

Freeland said the stimulus package was meant to make Canadians’ lives “a little bit easier, now that we have the space to do so.” Asked whether it would be funded by other taxes, spending cuts or deeper deficits, Trudeau responded that Canada’s debt-to-gross domestic product ratio is the lowest in the Group of Seven and the country’s long-term fiscal picture is sustainable.

But as the government opens the door to more outlays, questions remain about the state of Canada’s finances. Freeland has yet to report final spending and revenue numbers for the last fiscal year, though they are usually released in October. Parliamentary Budget Officer Yves Giroux expects a deficit of C$46.8 billion, blowing past Freeland’s self-imposed target of a C$40 billion shortfall.

“Even before this announcement it looked like one of the guardrails was going to be violated,” Schleich said. “It was already going to be a worse fiscal trajectory than the one laid out in the budget and these announcements certainly don’t help.”

Return to ‘Fiscal Activism’

The Trudeau government continued to boost spending even as it pledged smaller deficits. In this year’s budget, it offset new housing and social programs with a new capital gains tax inclusion rate. That prompted a backlash from investors and entrepreneurs, but it helped Freeland project a steady deficit despite major expenditures.

The new announcement suggests Trudeau’s government no longer feels constrained in its ability to deploy fiscal stimulus to regain popularity. Pierre Poilievre’s Conservatives have been about 20 points ahead in most polls for more than a year, hammering the prime minister on affordability and promising to cut taxes, including on income. An election is expected by late October 2025.

The sales tax break is set to run from Dec. 14 to Feb. 15. The left-wing New Democratic Party plans to support it, but said it would continue to campaign to make it permanent and expand it to more items. The government will also face pressure from voters to make it permanent, said Bank of Nova Scotia economist Rebekah Young, which would significantly raise the cost of the policy.

The spending is emblematic of the “fiscal activism that has been a hallmark of the government,” Young said in an interview. The country’s debt has risen to over 40% of GDP, after massive expenditures during the Covid-19 era.

“I think it’s certainly being guided toward more fiscal spending than less fiscal spending over the next couple quarters in Canada at least,” Young said.

After Trudeau’s announcement, traders in overnight swap markets pared bets that the Bank of Canada would deliver a second consecutive 50 basis-point cut in December, putting the odds at less than 25% by the end of Thursday. As of late Friday morning, those odds were below 17%.

The news also prompted some economists to raise their near-term forecasts for Canada’s economy. Analysts at the Bank of Montreal say the country’s gross domestic product will grow at a 2.5% annualized pace in the first three months of 2025, up from 1.7% previously.

“The combination of the new stimulus, more cautious Fed, upside inflation miss, along with an anticipated upward revision to GDP, should all but take a 50 basis-point cut off the table in December,” rates strategist Benjamin Reitzes said.

Speaking to reporters Friday, Trudeau touted his government’s approach to program spending, saying it’s creating optimism and opportunities for families and the middle class.

“We’re focused on Canadians. Let the bankers worry about the economy.”

--With assistance from Jay Zhao-Murray and Monique Mulima.

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