By Fergal Smith

TORONTO (Reuters) – Prime Minister Justin Trudeau risks further fueling Canada’s hot inflation if he presses ahead with spending plans outlined during the election campaign, which could pressure the Bank of Canada to hike interest rates sooner than planned.

Trudeau’s Liberals are promising C$78 billion (or 61.6 billion dollars) of new spending in five years. That is about 4% gross domestic product. This would add to C$101 billion of additional spending for three years, which was approved in the budget this year.

Preliminary election results showed the Liberals winning with another minority government. They will have to collaborate again with opposition lawmakers such as the New Democratic Party (left-leaning), which has its own spending priorities.

Tony Stillo from Oxford Economics, the director of Canada Economics at Oxford Economics said that when you see such a stimulus hit the economy we believe it might prompt the Bank of Canada into action.

We think that the economy will absorb the excess slack quickly and could even be fully operational by next year.

The central bank has been expected to tighten its stance over the following year by adding 14 basis points. Money market traders have anticipated a rate increase as early as July.

The BOC did not comment.

Inflation pressures can be increased by increasing expenditures and reducing economic activity. Canada’s August annual inflation rate rose to 4.1% in August. This is well beyond the Bank of Canada’s target of 1%-3%.

While the central bank is reducing its bond purchases, it will wait for economic recovery before raising interest rates to 0.25%. In its latest forecasts, the central bank predicts that a return of full capacity will take place in 2022’s second half.

SUPPLY SIDE

Trudeau has repeatedly dodged questions about the inflationary impact of his spending plans, saying his focus was on helping Canadian families and those struggling with the pandemic. He said to reporters early in his campaign that he didn’t consider monetary policy.

However, evidence that inflation is being lifted by supply chain problems and labor shortages could suggest that the economy doesn’t need additional stimuli.

Doug Porter of BMO Capital markets, chief economist said that supply-side concerns are limiting the economy more than too much demand. The risks of inflation are “high” because there is more fiscal spending.

Canada’s economy should rebound following its unexpectedly weakening second quarter. The employment rate has also risen to 1% below pre-pandemic levels.

Pedro Antunes (Chair economist of the Conference Board of Canada), stated, “The economy is back and employment has rebounded.” With these programs, there are an abundance of savings. There is also a great deal of profit in the current economy.

($1 = 1.2656 Canadian dollars)