With the 2019 federal election result producing a minority Liberal government that will likely be supported on key confidence questions involving spending priorities by the New Democratic Party, Canada is set to continue the deficit spending of the past four years. Otherwise, as BMO’s Doug Porter and Robert Kavcic write in this post-election BMO briefing adapted for Policy, the markets took the outcome in stride. 

Douglas Porter and Robert Kavcic 

While the Liberal minority outcome on Oct. 21 may have surprised some, financial markets had largely been braced for a minority government since the day the election was called in mid-September, so the broad-brush outcome was expected and market reaction was muted. 

Canada has a long history of dealing with minority governments, of various stripes, most recently with three different versions spanning from 2004 to 2011. Typically, markets and the economy are driven by much bigger global forces than domestic political considerations. The main point is that we are likely dealing with somewhat less clarity on policy, and key economic issues are expected to be dealt with on a case-by-case basis. There will be plenty of horse-trading ahead of next year’s budget. The first real sense we’ll get on that front will be the government’s throne speech, when it sets out its priorities, and will be treated as a confidence issue.

While, theoretically, any party can support the Liberals, the NDP are the consensus first choice to step up and deal, partly because many issues in the two platforms overlap nicely. For example, both parties are in line on the carbon tax; both are looking to crack down further on non-resident ownership in real estate; they’re each seeking to expand pharmacare; both want to cut cell phone bills; and, neither sees any need to balance the budget.

But, it will likely take more to earn NDP support, with the party outlining priorities during the campaign that included a wealth tax, national dental care program, elimination of subsidies to the oil sector, and waiving interest on student loans. Of course, the ruling party need not accept every demand, but that’s a rough initial take on what might be on the table. All told, if that’s how the support lines are drawn, the first budget could look a lot like past Liberal budgets, but with spending commitments and deficits scaled up a few more notches even beyond those laid out in the Liberal platform.

Here are a few of the key implications we can draw for the economy, some sectors, and financial markets:

It’s highly likely that we will see a further net loosening in fiscal policy—i.e., a wider budget deficit—with a minority government. It’s not yet crystal clear where the major spending changes will come from, but even the Liberals were projecting larger deficits in the coming years compared with this year’s budget, and that was before any specific demands from other parties. For example, the Liberal campaign pledges were projected to widen the deficit to $27.4 billion for FY20/21 (or about 1.2 per cent of GDP), and then narrow only modestly to $21.0 billion by FY23/24. That compares with an expected deficit this fiscal year of $19.8 billion (or 0.9 per cent of GDP) and just $14.0 billion (0.6 per cent of GDP) reported in the FY18/19 public accounts.

Meantime, the Liberal platform doesn’t appear to include the cost of a national pharmacare program, a key NDP demand, and one on which the Liberals would likely be willing to cooperate. The cost of such a program could run in excess of $10 billion per year. Other likely NDP demands, such as dental care, housing investments and student loans could run around $4 billion, offset partly by closing loopholes or possibly even some form of wealth tax. 

The de facto fiscal target of this government had been a stable debt/GDP ratio (of just over 30 per cent)—that’s not going to hold with deficits of the magnitude we’re now likely to face in coming years. While there is nothing magical about the 30 per cent level, a rise in the debt/GDP ratio would weaken Ottawa’s fiscal position heading into the next downturn, leaving them less room to maneuver and possibly leading to a loss of Canada’s coveted triple-A status down the line.

The Liberal platform included roughly $2 billion of net tax increases by FY21/22, including a 10 per cent luxury tax on vehicles, planes or boats above $100,000, and closing various loopholes.

The NDP will surely look to increase taxes on higher-income earners or wealthy Canadians. Their proposed 1 per cent wealth tax (a possible sticking point for support) would apply annually to those with net worth greater than $20 million. Higher corporate tax rates, top marginal rates and capital gains taxes were also featured in their platform, and could be alternatives. There’s no certainty that these proposals will be accepted, but a few may receive a long look from Finance to help pay for some of the big-ticket spending plans.  

A Liberal/NDP mandate could see a much more active involvement in housing markets in a bid to improve affordability. The NDP proposal to “create” a half million affordable units over a decade (50,000 per year) would boost annual housing starts by about one quarter, so it’s a material pledge. But the question is: how can that be accomplished, and would it involve subsidizing builders or buyers? If the latter, the boost to demand could neutralize the restraining effect on prices of new supply. 

As a standalone development, a loosening in fiscal policy would temporarily lift GDP for a spell, on roughly a one-for-one basis. So, a rise in the budget deficit to around $30 billion (or 1.2 per cent of GDP) by 2021 could lift GDP by roughly 0.4 percentage points by that time. However, that could be offset by a dimmed outlook for the energy sector, heightened business caution, or somewhat higher interest rates than would otherwise be the case. We will not fine-tune our growth outlook for Canada until we get more clarity on broad spending and budget plans from the new government. We are currently expecting growth to be 1.5 per cent this year, and pick up slightly to 1.7 per cent in 2020. The small improvement next year is driven by: 1) less drag from oil production cuts in Alberta, 2) a firmer housing market; and, 3) modest fiscal stimulus that was in place even before the election.

A looser fiscal policy and the potential for firmer growth could keep the Bank of Canada on hold for longer. With most major central banks cutting interest rates recently, or preparing to cut further, the BoC is highly unlikely to step in the opposite direction. We look for rates to stay steady for the foreseeable future, with an easier fiscal policy (i.e., larger budget deficit) providing the stimulus instead.

For bond yields, larger budget deficits than previously planned and the related ramp-up in borrowing requirements may put some slight upward pressure on Canadian yields versus others. Still, bond markets are barely responsive to budget deficits in most cases these days—witness the plunge in U.S. Treasury yields in the past year, even as the U.S. budget deficit forged higher to nearly $1 trillion (or over 4.5 per cent of GDP). 

The Canadian dollar managed to strengthen during the course of the election campaign and in the days after, partly due to the fact that markets had long since assumed a minority government outcome, and partly due to fundamental factors. First, the U.S. dollar has weakened moderately in recent weeks as the tone around the Brexit negotiations and trade with China has improved. Second, mostly firm Canadian domestic data—especially on housing and jobs—have markedly reduced odds of the Bank of Canada trimming interest rates anytime soon.

Looking ahead, we expect global factors to dominate domestic political considerations, which may otherwise be a modest dampener on the currency. On balance, we are slightly constructive on the loonie despite the political backdrop, with oil prices expected to hold in the mid-$50 range, Canadian interest rates holding at the high end of the range among major economies, and a less negative tone in the U.S./China trade battle.

There’s not much to move the needle on equities broadly, as growth concerns, interest rates and oil prices are much bigger factors. And, unlike the cannabis sector in 2015, there’s no apparent big winner from this result. On the flip side, both the Liberals and NDP have actively endorsed cutting cell phone bills. What form that takes (i.e., through regulation, subsidies or more competition) is unclear, but is something to watch in the telecom sector. Finally, for the energy sector, it would clearly be a net loser if Trans Mountain faces any further delay, as that project is an anticipated relief valve for Alberta crude supplies and Western Canadian Select prices.  

Douglas Porter is chief economist and Robert Kavcic is a senior economist with BMO Financial Group.