The stunning Liberal victory across the country puts to rest the spectre of political uncertainty. As the news broke, the Canadian dollar was more resilient than expected. Indeed, by the time the national media predicted a Liberal majority government, the Canadian dollar was recovering from its initial drop, showing that Trudeau was seen by the world as no bogeyman.
Clearly, economic policy in Canada will be rebalanced. Monetary policy will now take a backseat to fiscal stimulus, ending a decade of doggedly balanced budgets and ever-lower interest rates. While much is yet to be determined, the Liberals will increase government spending, particularly for public transit, social and green infrastructure, running budget deficits for the next three years of up to an estimated $10 billion per year. Boldly, the Trudeau Liberals have been willing to break the Conservative shibboleth of debt reduction. Even the NDP in this election supported a balanced budget.
This takes the pressure off of the Bank of Canada to lower rates. No doubt the Bank will stand pat at Wednesday’s meeting. Government bond yields have likely bottomed at levels well below those in the U.S. As of this morning, the 10-year Canadian government bond yield was a mere 1.45 percent, 57 basis points below the level in the U.S. Some large foreign investors in Canadian government bonds suggested yesterday that a strong Liberal win would dampen their purchases, but there is no doubt of the nation’s ability to fund extra spending. Canadian public finances are sound and the debt-to-GDP ratio is among the lowest in the world. On balance, however, medium- and longer-term interest rates will be higher than they otherwise would have been, hiking mortgage rates, at least moderately.
Moody’s and The Economist magazine have recently expressed renewed concern of a housing bubble in Toronto and Vancouver, reminding us once again that Canadian household debt levels are at record highs and that house prices in both regions have risen far faster than incomes. With the change in government, housing will no longer be the driving force of economic expansion as mortgage rates have no doubt bottomed. Rate increases, however, will likely be moderate and gradual.
The Liberals will increase taxes for top earners while reducing them for the middle class. They have also promised to eliminate income splitting and take Tax Free Saving Account contribution limits back down to $5500 from the recent rise to $10,000. Unlike the Democratic front runner, Hillary Clinton, the Liberals support the Trans Pacific Partnership trade agreement.
Bottom Line: This result is better for the economy than a minority government–either Liberal or Conservative. It is a new day, and the details of Liberal policy have yet to be hammered out, but clearly, the first order of business for Prime Minister Trudeau will be to provide meaningful fiscal stimulus to an underperforming Canadian economy. People wanted change and change is what they will get.