Markets are watching with growing alarm as Canada’s economy shows increasing signs of fragility, with the loonie sliding, bond yields rising, and capital flight accelerating. The contrast with the United Kingdom’s renewed fiscal conservatism could not be starker, and it is a lesson in the virtue of discipline.
Canada’s fiscal position has deteriorated markedly. The federal deficit for the fiscal year ending March 2024 is projected to exceed C$40 billion, nearly double the pre-pandemic forecast. Public debt has ballooned to over 100% of GDP, and the debt-to-revenue ratio is now at levels that would make a British chancellor wince. The Liberals have been spending as though there is no tomorrow, and the markets are beginning to ask: who is going to pay for this?
Inflation, while moderating from its peak of 8.1% in 2022, remains stubbornly above the Bank of Canada’s 2% target at 2.9%. This has forced the central bank to maintain high interest rates, currently at 5.00%, which is choking economic activity. GDP growth has stalled, with Q2 2024 showing an annualised contraction of 0.2%. The housing market, once the engine of Canadian wealth, is now a drag, with prices down 15% from their 2022 peak and mortgage defaults rising.
Capital is fleeing. Net foreign portfolio investment in Canadian bonds has turned negative for the first time since the global financial crisis, as investors seek safer havens. The British gilt market, by contrast, has seen steady inflows since the new government’s fiscal responsibility mandate was announced. The yield on a 10-year Canadian government bond is now 3.85%, versus 4.15% on the equivalent gilt – a spread that would have been unthinkable five years ago when Canada was seen as the more prudent nation.
The root cause is a lack of fiscal credibility. Canada’s government has no medium-term fiscal plan, no independent budget watchdog with teeth, and a history of broken promises on deficit reduction. The contrast with the UK’s Office for Budget Responsibility, which holds the Treasury’s feet to the fire with its regular fiscal forecasts, is instructive. Markets crave predictability, and Canada is offering anything but.
Meanwhile, the Bank of Canada is caught between a rock and a hard place. If it cuts rates to stimulate growth, it risks reigniting inflation and further devaluing the currency. If it holds tight, it deepens the recession. The central bank’s governor has been reduced to pleading for fiscal discipline from Ottawa, but the government’s response has been more spending promises.
The consequences are already being felt by ordinary Canadians. Mortgage payments have soared, with variable-rate holders seeing monthly bills double. Unemployment is creeping up, currently at 5.8% and rising. Business investment is falling as firms relocate to more stable jurisdictions. The manufacturing sector is in recession, hit by high costs and weak demand.
Across the Atlantic, the UK has been through its own trauma, but the response has been different. The new government, chastened by the Truss debacle, has embraced fiscal rules, established a new fiscal council, and committed to reducing the deficit. The result? Gilt yields have stabilised, inflation is falling faster, and the pound has regained strength. The contrast is not lost on global investors.
Canada’s problem is not unique, but it is acute. The country has ridden a commodities boom and a housing bubble to prosperity, but the hangover is upon it. Without a credible commitment to fiscal discipline, the outlook is grim. The Bank of Canada may be forced to cut rates regardless, sending the Canadian dollar into a tailspin and importing further inflation.
For the British reader, there is a parable here. The siren song of big government spending may be seductive, but it ends badly. The market’s verdict is final, and Canada is now paying the price for years of profligacy. The question is whether other nations will learn the lesson before the music stops.
