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Economic and Fiscal Outlook October 2018.pdf
The Canadian economy continued to operate above its potential output in the first half of 2018. Fuelled by strong export growth, real GDP growth averaged 2.2 per cent in the first two quarters of the year.[i] As underlying inflation moved up to the 2 per cent target and wage growth improved, the Bank of Canada raised its policy interest rate by 25 basis points in January and again in July.
While Canadian economic performance remains solid, we continue to monitor macroeconomic developments and risks to the outlook, adjusting our key assumptions and judgements accordingly. In particular:
- We assume that negative trade actions will reduce Canada’s GDP by 0.25 per cent by 2022;
- We assume that the U.S. Tax Cuts and Jobs Act will not have a material impact on Canada’s investment climate;
- We assume that the Bank of Canada will steadily increase its policy interest rate through early 2020.
- We expect households’ financial vulnerability to increase as interest rates rise and their debt-servicing capacity is stretched further.
Looking ahead, we project real GDP in Canada to advance by 2.1 per cent in 2018 and 1.8 per cent in 2019 before slowing to growth of 1.5 per cent annually, on average, over 2020 to 2023.
Over the medium term, we continue to expect the Canadian economy to rely less on consumer spending and the housing sector as business investment and exports make a greater contribution to economic growth. Indeed, we expect a significant contraction in residential investment and a deceleration in house prices through 2020.
With the economy continuing to operate above its potential output and inflation running above the Bank of Canada’s target, we assume that the Bank will increase its policy interest rate by 25 basis points each quarter until the policy rate is returned to its (nominal) neutral level of 3.0 per cent by the first quarter of 2020.
[i]. This report incorporates data available up to and including 19 October 2018. Unless otherwise specified, all rates are reported at annual rates.
PBO’s economic outlook reflects the view that possible upside and downside outcomes are, broadly speaking, equally likely. In terms of downside risks, we believe that the most important risk is weaker export performance. In terms of upside risks, we maintain that the most important risk is stronger household spending.
Our fiscal outlook takes into account recent policy changes in Canada and abroad. We estimate that Canadian tariffs on imports of steel, aluminum and other products from the United States will generate additional revenue of $1.3 billion in 2018-19 and $1.8 billion in 2019-20. However, we assume these measures will have no net fiscal impact, as revenue from these tariffs will be redirected dollar-for-dollar as spending to support affected industries.
We also assume that recent U.S. corporate tax changes will result in multinational corporations shifting some of their profits from Canada to the United States, resulting in lower federal corporate income tax revenues of $500 million annually, on average.
For the current fiscal year, 2018-19, we project that the budgetary deficit will be $19.4 billion (0.8 per cent of GDP), slightly higher than the budgetary deficit of $19.0 billion in 2017-18. Our fiscal projection reflects the recent change in the Government’s discount rate methodology. Our projections are based on preliminary assumptions about the future impacts of this accounting change on the Government’s operating expenses and public debt charges.
Over the remainder of our outlook, we project the budgetary balance to reach a deficit of $9.4 billion in 2023-24 (0.4 per cent of GDP). The projected decline in the deficit relative to the size of the economy reflects growth in income tax revenue that exceeds nominal GDP while growth in the Government’s operating expenses remains restrained. This restraint stems from falling expenses for federal employees’ future benefits and limited growth in federal personnel.
We estimate that there is approximately a 10 per cent chance that the budget will be balanced or in surplus in 2021-22. The probability of budgetary balance/surplus rises to 30 per cent in 2023-24. In addition, we estimate that in 2020-21, there is approximately an 80 per cent chance that the federal debt-to-GDP ratio will be below the Government’s anchor of 31.8 per cent.