Aggressive Bank of Canada rate hikes could add more strain on Ottawa’s debt servicing

When Finance Minister Freeland delivered the federal budget in April, the Bank of Canada had just begun its hiking cycle and interest rates were at a measly half a percentage point. She will face a new financial reality when she rises in the House of Commons in November.

In the seven months between, the central bank's policy rate has soared to 3.75 per cent and similar moves around the world are forcing governments to seriously consider the rising cost of servicing their debts

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The central bank's mission to stomp out decades-high inflation puts upward pressure on public borrowing costs and could cause a recession if it is not stopped.

The current risk outlook leans more toward larger deficits despite the fact that the finances have been improving since the depths of the swine flu.

Growing debt costs and recession risks go hand-in-hand. Revenue growth slows and expense growth increases as a result of an economic downturn. The economic downturn can be traced back to higher inflation feeding into higher spending and higher interest rates. It's a perfect storm for a weak fiscal forecast.

The government of Canada's borrowing costs are set to rise sharply with the central bank's series of outsized rate increases but will still remain lower in a broader historical context.

Canada's federal government stands out due to its shorter-term debt obligations compared to other advanced economies. This didn't change a lot during the Pandemic.

The Government of Canada will feel the impact of higher interest rates more quickly than other countries. As the effective interest rate on the federal debt increases, we are of the opinion that public debt charges will increase more quickly than anticipated by the parliamentary budget officer.

It has been a while since interest costs have been a focus of the government's finances.

Interest costs have been a factor in government finance for the first time in decades. They were the main driver of government finances through most of the ’80s and ’90s, but they have faded as a key driver of government finances.

Porter said that the risk of higher borrowing costs has gone up since the government took on a lot of debt. While the economy has grown significantly since the mid 1990s and current debt service costs are relatively manageable, he noted that recent monthly debt charges were not far from that era's all-time highs.

According to the head of capital market economics at Scotia, rising rates will have a significant impact on the federal government's finances. Holt noted that during the spring budget earlier this year, the government projected public debt charges to increase to $43 billion in the fifth year of their projection.

Holt said that the assumptions upon which the increase in public debt charges are based are looking pretty optimistic now. They are absolutely wrong.

They're completely incorrect.

There is a person namedDerek Holt.

Holt said that it would bring forward the upward trajectory within the next year or two. It is a way of crowding out what they could otherwise be spending on other initiatives.

Holt doesn't think there will be a return to austerity with this week's fiscal update. The government may be stuck between a rock and a hard place as it tries to appease the New Democratic Party with a dental care package and avoid market scrutiny with more spending.

If you back off on some of the budget spending amounts, you are either going up against the pacts between the Liberals and the New Democrats, or you are going to get markets breathing down your neck.

While austerity may not be the order of the day, Benjamin Tal is among those who does not expect a lot of new spending measures that would make the Bank of Canada's fight against inflation more difficult.

Tal said that the update would be light on new spending and that higher rates would limit ability to spend. They won't sabotage monetary policy. The Bank of Canada is not the same as that.

There is a stark mismatch between fiscal and monetary policy in the United Kingdom. When the prime minister included a corporate tax freeze in her budget plan without explaining how it would be funded, the yield on government bonds went up. She had to leave.

Porter thinks that the Department of Finance will learn from it.

Porter said that the finance department got the message loud and clear that there was too much stimulation in the economy in the last couple of years.

The email address is shughes@postmedia.